Public finance to improve outcomes

hina blog pic
By Hina Shaikh

Pakistan continues to face significant social and economic challenges. Provision of basic services such as health and education falls short of international standards, while women and the poor are often wholly excluded from accessing these services. At a time when the government is under pressure to demonstrate fiscal restraint, a strong public financial management system can help state institutions improve service delivery geared towards promoting both economic growth and poverty reduction.

A strong financial management system needs three things – aggregate fiscal discipline, strategic allocation and prioritisation, and operational efficiency in service delivery. Pakistan lacks on all three fronts. Its system of governance rests on weak financial planning and poor performance management coupled with a lack of accountability across all levels of government. This blog looks at some of these challenges and what the new government can do to fix these.

Snapshot of a typical budget: Allocation versus execution

In the case of Pakistan, public financing, especially for the social sector exhibits certain patterns that are pervasive and consistent across different levels of government. While these trends are easy to identify and understand, they may not be as easy to correct.

One such example is the case of the sectoral allocations, which largely go towards non-development spending, and overall disbursements remain dominated by salary expenditure. Development expenditure forms a minor chunk of the entire budget and is plagued by low utilisation of funds. This is in addition to the consistently low overall allocations towards the social sector as a share of the total budget. Pakistan spends less than one percent of total GDP on health and close to 2 percent on education.

Let’s take the example of the public education sector in Punjab. It employs the largest workforce (around 400,000 employees), runs more than 52,000 schools and enrols more than 12 million students in the province. Overall expenditure on education has grown by an average of 6 percent each year between 2010-11 and 2016-17 with an average spending of 17 percent of the total provincial budget. Within the same period, non-development budget remained above 90 percent. On the budget execution side, utilisation of non-development budget remained high (above 90 percent, touching 99 percent in 2012-13). However, utilization of non-salary and development budget in the same period remained low at an average of 65 and 50 percent respectively. This usually happens on account of two factors: lack of capacity to spend and/or delay in release of funds by the provincial governments.

Gaps in public financing are also aggravated by the sheer size of the sector. With over 50,000 spending units (schools), the government’s accounting system is not sophisticated enough to be linked with, or capable of monitoring, each of these units. At the same time improvements in learning outcomes are only marginal. There is often a faint link between budgetary allocations and overall development outcomes. Despite a substantial increase in the development budget for Punjab’s education sector, over 11 million children in the province still remain out of school.

The example of the education sector points to an obvious gap between what is being allocated, spent and achieved. The situation is similar in other sectors, which is why Punjab was only able to spend 65 percent of its PKR 635 billion development budget in 2018. Some of this can be attributed to the mode of service delivery. Service delivery propagated through the roadmap approach, for example, focuses on a limited set of indicators, at the cost of the bigger picture. There is thus little accountability within the system in terms of meeting the broader, more policy level sectoral objectives.

While Pakistan struggles with the scarcity of high-quality data, existing household surveys should enable policymakers to assess whether impact against certain fundamental indicators has been achieved. Why is then the budget delinked with outcomes?

Lack of sectoral strategies

Budget exercises unguided by an overarching sectoral strategy or policy lead to poor execution. Hence outcomes remain unchanged. Most interventions are ad-hoc and designed on political whims, rather than on actual demand or a sectoral plan. The use of ‘quick-win’, limited target roadmaps to implement service delivery leads to investment in areas that do not address the root cause of the sector’s underperformance. The school education roadmap focused on reducing out of school children at the primary level without allocating adequate resources to secondary education. This means an increase in drop-outs at a later stage i.e. more out of school children at the secondary level. Moreover, the budget making process is driven more by the available fiscal space and less by government priorities. Thus, the budget is invariably an incremental one.

Development overshadowed by political priorities

Elected politicians are held accountable on service delivery rather than on their ability to legislate or make new policies. They have little incentives to develop sectoral strategies, or deliver on the promises of sectoral strategies in the rare instance when they do exist. They want immediate results and hence focus on tangible development rather than softer interventions. Hence, development budgets are essentially determined by political priorities – be it recruiting 80,000 teachers or creating 2 million jobs. These priorities, regardless of whether they help achieve broader development goals or not, are met to gain political mileage. Subsequently, policy clarity is undermined as politicians end up battling with bureaucrats for space in the service delivery domain.

Overestimation of fiscal space

Pakistan does not practice aggregate fiscal discipline as its annual expenditures are seldom aligned to its revenues. Provinces forecast spending on the basis of projected revenue transfers from the federal government, which typically overestimates tax collection. Spending decisions are thus based on a fictitious number. This reduces the predictability of the budget, and leads to re-prioritisation which is both expensive and disruptive. Release of adequate funds becomes a concern and most often impacts development expenditures. Funds allocated towards infrastructure projects – the more visible and politically salient investments – are disbursed swiftly while softer interventions are put on the back-burner. There is little learning within the system and provinces continue to witness an annual budget shortfall year after year. The fiscal space for development thus keeps reducing.

What next?

The underlying mantra for improving financial planning is that it must be embedded in an understanding of the government’s key policies, priorities and capacity to deliver. It must also be forward looking and pre-emptive.

In the case of Pakistan, budgetary decisions are not informed by any sound analysis or sectoral view. Parliamentary debates on the budget turn into political tussles and seldom focus on the rationale behind stated allocations. The budget document itself is full of complex jargon, rendering it incomprehensible for parliamentarians. Moving forward, Pakistan can draw lessons from Korea, which has set up a national assembly budget office consisting of a team of chartered accountants, lawyers and economists to continuously inform parliament’s debate on the budget.

The new government appears fully empowered to take on the required restructuring of the budget by strengthening line departments that have typically left the responsibility of public financial management to the finance department. Line department must play a central role in providing direction to financial plans and setting milestones. These departments are also well placed to decide on the most efficient way to achieve these milestone, given limited capacity and resources.

Despite the fact that the new government has inherited a difficult fiscal situation, the solution does not lie in simply reducing expenditure but in fact in enhancing it at the right place. Government can and should focus on both improving public financial management practices at all tiers, and rationalising recurrent expenses without compromising drastically on development allocations.

Hina Shaikh is the Country Economist at the International Growth Centre (IGC)

One comment

  1. Pakistan EXIM iunits needs USD finance TODAY

    Anyone can raise capital in USD today – irrespective of central bank caveats.2 years ago,it was unviable and difficult. Today, it is VIABLE and EASY – all due to COVID.

    Pakistan has staged a miraculous COVID turnaround and this is the next turn – ULTRA LOW COST FINANCE.dindooohindoo

    Case 1

    Take the US LIBOR (6 months BBA) at 30 BP in August 2020,id.est 0.30 %

    Assuming a spread of,say 50 BPs for a bank like Habib Bank – a 1st Class Scheduled Bank (as it gets the LOC or Borrowing on the strength of its Balance sheet)

    Habib will onlend it to Pakistan SMEs at say a spread of 150-250 BP
    Aggregate USD lending rate will be 1.8 to 2.8%

    If the borrower is an exporter,and is raising Packing credit,which will liquidate in 3 or 6 months – he keeps an open exposure on the USD loans,qnd offsets it with the USD export collections

    It SOUNDS good – but it is not a CERTAIN gain,as there CAN BE an OPPORTUNITY loss

    If PKR falls by 5 % in 6 months and if Export Packing Credit is available in PKR at,say 9%,then post the PKR rupee loss,the NET COST of the Packing Credit,in PKR = Minus 100 BP.

    But still there are people who do not want to take any view on the PKR/INR markets – and so,they want to borrow in USD so that they have outsourced their FX nominal risk,to a neutered FX exposure

    SO HOW SHOULD PAKISTANI ENTITIES,RAISE USD LOANS ? It is fairly simple ! There are 3 Options

    Option 1

    1st Take the Export Packing Credit loan in PKR,at say,750-1000 BPs of say 500 Million PKR (as banks do not want to lend in USD,as then,no one will take PKR loans !)

    Assume this is a 6 months credit,and so,exports are expected at 1 Billion PKR in 1 year
    For 50% of the borrowing,and assuming exports as above,the borrower should short the dollar (forwards only) and get a premium of say between 500 – 900 BPs,at various points of time

    So on a Net basis,you have a USD borrowing of 50% of 500 Million PKR,at 250 – 100 BP,and it is on TAP,as the entity will drawdown the Packing credit,when it wants,and short the USD,when it wants

    On the Date of the liquidation of the Forward contract,he has to get the USD “FROM SOMEWHERE”.Even if there is a War,the borrower will MANAGE to get the USD from somewhere

    Option 2

    If the prospective borrower is an exporter,then he should import duty free on duty free licences.

    For that he will need to import,and so,will need to import,on Import Usance LCs or Buyer LCs

    In a LC,the overseas supplier,is taking a risk on Habib Bank (who opens the LC) and the UCP Rules

    With 6 Months US Libor at 0.30%,the supplier can give a 6 months LC credit at Nil interest rates (subject to his exposure norms)

    Some suppliers and overseas banks,MIGHT not accept Habib Bank LCs,and so the LCs will need to be confirmed (with confirmation charges)

    A Pakistani exporter with a 200 Million USD Top line,should be able to open LCs on an annualised cost of 125- 150 BPs

    A Pakistani exporter with a 500 Million USD Top line,should be able to open LCs on a FIXED advalorem cost of say 100 USD per LC – which will make the annualised cost close to ZERO %
    But if such an exporter needs to pay a % fees,then he should enter into clean credit discounting arrangement or a factoring/forfaiting deal,with some international bankers in London/Singapore etc or use the discounting limits of the suppliet.

    For those exporters who cannot open LCs – they can use 3 rd party financiers to open the LCs,and convert their finance cost,into USD,And then, the LCs can be Rolled on and on and on – until the SBP calls up the borrower

    So,in import finance,if the LC costs are lowered or converted into a fixed value,and LC confirmation is waived by the foreign supplier or his bank – a Pakistani exporter can easily raise working capital finance at ZERO % cost,IN USD (and set off the LC retirement, with the foreign remittances).

    This all excludes LC engineering like Transferable/Diviisble LCs etc.

    But the cost can be made NEGATIVE easily, if the imports are on Duty Free Licences,from a Front company,in say,Dubai.

    So if the importer overstates the LC amount – he raises an ECB at Zero % cost or Near Zero Cost – and the extra funds,are parked with the Front company for rotation.The PKR hedged
    cost of that extra fund,will be less than the Habib Bank PLR

    Option 3

    Even for Pakistani entities who have no exports,their imports can be financed at 100-200BP per annum,on LCs or on Clean Credit (for regular importers)

    Even after loading the FX premiums the loaded cost should be 6-8%,which will be much lower than the CP or CD rates in Pakistan

    For Regular importers with perfect payment history,the suppliers can do recourse and non-recourse financing, by discounting the drafts on the Pakistani importers,or holding the bills to maturity (obviating the LC)

    Better still,the overseas suppliers can discount the drafts on Pakistani importers,with Pakistani Billionaires in London – who are parking their cash in the call market at 0.10%.They can be offered 100 BPs !

    In some cases,the Pakistani Importer and the Pakistani Billionaires,might be the same person,but with different legal entities

    The Problem

    The Problem is that Pakistani Banks find “not so creative” tools,to make USD financing unviable,for Pakistani entities – by loading ad valorem % charges,which on an annualised basis,make the transaction unviable

    Hence,at least for imports (unlike exports,where an exporter can short the USD to swap the PKR loan into a USD Loan),the Pakistani entities have to use supplier financing,and tie up with banks,in London etc., to discount,negotiate,factor and forfait their bills/drafts.

    Basically,it is the Country Risk of Pakistan (created by Indian Vilification) which causes the chain of confirming,advising and other charges,which make the LC transaction unviable, from Pakistani Banks.

    Many Pakistani exporters will have a payment rating and credit rating – HIGHER THAN THE PAKISTAN SOVERIGN and also,that of HABIB bank (as Habib is exposed to the economic and credit risk,of Pakistan and its Banking system)

    Hence,the time has come for some Pakistani Millionaires and Billionaires to use their surplus cash parked in T-Bills etc., to open a EXIM bank in London or Dubai,to use creative exim financing options ONLY for Pakistani Exporters and Importers (beyond a certain size).That will slash the costs of Pakistani EXIM units,and also,the said EXIM bank,can be used to offer innovative credit default options,on clean credit exports,by Pakistani exporters,to Africa and other nations.

    If the Pakistani Millionaires put in,say USD 50 million,in equity and raise USD 200 in debt,then in one year,their primary discounting and financing business,assuming a 3 months tenor,will be a Billion USD,and if they start offloading and re-discounting the bills,with other bankers and financiers – the aggregate financing turnover,should be 10-15 Billion USD – on a seed of USD 50 Million.There is no way,the millionaires will earn that kind of yield,in any Junk Bond in the world

    Only a Pakistani can appraise the credit and intent of a Pakistani borrower,and also,have the ability to make the borrower PAY.

    Like

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