Forecasting Punjab Revenue and Expenditure Anjum Nasim May

Forecasting Punjab Revenue and Expenditure Anjum Nasim May, 2017

Federal and Provincial Annual Budgets • Each year the budget of the federal/provincial government is presented for the new financial year (beginning July 1). • The budget session is kicked off by the finance minister’s speech. • Through this and related budget documents, the government briefs the public about: • • its performance in the recent past its economic agenda in the near term the detailed breakup of its planned expenditure in the new financial year sources of financing the expenditure including tax revenue, non-tax revenue and borrowing

Constitutional Aspects • Pakistan has a federal constitutional structure. The constitution of Pakistan assigns or establishes: • functional responsibilities to federal and provincial governments • the tax and non-tax revenues that these tiers can raise • institutional mechanisms for revenue sharing between the federal and provincial governments • The federal and provincial governments announce their budgets and place their finance bills before their respective assemblies. • The finance bills includes revenue-raising measures – generally tax measures to meet government expenditure. • The Annual Budget Statement (ABS), which contains budgetary estimates of government revenue and expenditure for the new financial year as well as revised figures for the financial year ending June 30 th, is also placed before the respective assemblies as part of the budget. • Constitutionally ABS is also part of the finance bill.

Constitutional Aspects • After the revenue measures have been debated and voted upon, and after discussion and/or voting on the expenditures given in ABS, the finance bill goes for approval to the president (or governor in the case of provincial budget). • After approval from president/governor, the finance bill becomes law, and gives legal authority to the respective governments to raise revenues and carry out expenditure. • The national/provincial assembly can reject a revenue proposal but cannot issue a revenue proposal on its own. • Similarly, an assembly is entitled to approve only cut motions on the expenditure side, i. e. to reduce expenditure but not increase any expenditure.

Constitutional Aspects • The governments can also change expenditure programs and priorities midstream and can depart from the expenditures approved by the legislative assemblies. • It is then required to place before the (relevant) assembly a supplementary budget statement, setting out the revised expenditures during the financial year. • The assemblies then deal with the supplementary or excess expenditure in the same manner as they deal with expenditure categories in the annual budget statement.

Punjab Budget Presentation: An overview • The Punjab government publishes a White Paper on the budget that accompanies other budget documents. • The White Paper first presents ‘General Abstract of Revenues and Expenditures’ along the lines of Table 1 (see next slide).

Table 1: General Abstract of Receipts and Expenditures Receipts General Revenue Receipts (GRR) Federal transfers (including excise duty on natural gas) Provincial tax revenue Provincial non-tax revenue Expenditures Current Revenue Expenditure (CRE) General public services Defense (not a provincial subject) Public order and safety affairs Economic affairs Environment protection Housing and community amenities Health Recreation, culture and religion Education affairs and services Social protection General Capital Receipts (GCR) Excluding Foreign Project Assistance Recoveries, loans and advances Debt Recoveries of investment – state trading schemes Cash credit accommodation Current Capital Expenditure (CCE) Public debt (Permanent debt (market loans)) Repayment of principal (CDL, foreign loans etc) Investments (including capitalization of pension fund) Loans and advances (principal) State trading in medical stores State trading in wheat Repayment of commercial bank loans Development Receipts Foreign project assistance (FPA) Development Expenditure (DE) Annual Development Programme Core ADP Other development initiatives Special initiatives

Methodology of the White Paper •

Methodology of the White Paper • In addition to these accounts, the coverage of the White Paper includes the Public Accounts of the province and its debt and contingent liabilities. • The practice of using Public Account funds for financing budgetary expenditures has been abandoned since FY 2008/09. • In our paper we will not concern ourselves with the Public Accounts of the provincial budget.

Forecasting Model - Nasim, 2016 • We have developed a forecasting model of Punjab’s revenues and spending. • Revenue forecasts: An outcome of several assumptions mostly about GDP growth and tax-to-GDP ratios consistent with medium to long term targets given in the IMF 7 th Review of the Extended Fund Facility (EFF) for Pakistan • Spending forecasts: Rely on policy targets and historical trends • Limitations: • Revenue targets can be compromised under political economy compulsions. • Historical trends of spending calculated from periods of low growth or of stringent borrowing constraint, may be poor indicators of these expenditures.

Forecasting Methodology- Nasim, 2016 How it differs from MTFF • Our forecasting approach differs from that followed in the Medium Term Fiscal Framework 2013 -14 to 2016 -17 (MTFF) of the Punjab government. • The MTFF forecasting framework involves: 1. forecasting resource envelope of the provincial government, which involves forecasting and adding: (i) tax revenue and non-tax revenue, (ii) transfers, (iii) grants, and (iv) net capital receipts (net borrowing/lending) 2. forecasting the level of current expenditures 3. determining development expenditure as a residual by subtracting current revenue expenditure from the resource envelope • In our forecasting framework, the balancing item is borrowing/lending of the government rather than development expenditure.

Forecasting Methodology- Nasim, 2016 • In the first stage, we forecast non-interest revenue receipts, development expenditure (DE), non-interest current revenue expenditure, disposal of non-financial assets, and net policy lending (NPL) in each period. • Next we estimate: • interest income in Year 1 as product of cash reserves in the base year and interest rate in Year 1 – reported in the budget as a non-development grant of the federal government • interest expense in Year 1 as product of debt in the base year and interest rate in Year 1

Forecasting Methodology- Nasim, 2016 • We then calculate: • Current Revenue Expenditure (CRE) in Year 1 as the sum of non-interest current expenditure in Year 1 and interest expenditure in Year 1 • General Revenue Receipts (GRR) in Year 1 as the sum of non-interest revenue receipts in Year 1, interest income in Year 1 and disposal of non-financial assets in Year 1 • Overall Fiscal Balance (OFB) in Year 1 by subtracting DE, CRE and NPL (in Year 1) from GRR in Year 1 • Financing Gap in Year 1 by subtracting debt repayments in Year 1 from OFB in Year 1 • Adjusted Financing Gap in Year 1 by adding a minimum level of foreign loans in Year 1 to the financing gap in Year 1 (by assuming the government will always tap into available low cost foreign financing).

Forecasting Methodology - Nasim, 2016 • If the adjusted financing gap is positive, it is assumed that it leads to a net addition in cash reserves. • If the gap is negative, we make assumptions about the sequence in which it is financed – through cash reserves, foreign loans and domestic loans. • These assumptions about financing, lead to determination of cash reserves in Year 1 and debt in Year 1. • Treating Year 1 as the base, we can forecast interest income and interest expense in Year 2, and consequently total revenue and total spending in Year 2. • Forecasts for each subsequent year are obtained similarly.

Forecasting Non-interest Revenue Receipts • We break down non-interest revenue into five categories: 1. 2. 3. 4. 5. Federal transfers from the divisible pool of tax revenue Punjab own tax revenues Transfer Under Article 161 of the Constitution and Clause 5 & 6 of the NFC award Federal/foreign development and non-development grants Non-tax revenue raised by the provincial government • Our categorization of non-interest revenue differs from those in the budgetary documents (see Nasim 2016, Box 4. 1 for details). • For forecasting revenue, we make assumptions for each of the five revenue categories mentioned above (see slide 17 -19 for examples). • Taken together, we make assumptions on variables listed in the following slide.

Forecasting Non-interest Revenue Receipts We make assumptions about the following variables: i. iii. Nominal GDP growth Tax-to-GDP ratio Ratio of federal divisible pool of taxes to total taxes and Punjab’s share in the divisible pool iv. Provincial share in total taxes and Punjab’s share in the provincial tax revenue v. Ratio of excise tax to total tax vi. Transfers on account of hydro-electricity profits vii. Ratio of royalties and development surcharges to total taxes viii. Non-development grants other than cash reserves ix. Interest rate on cash reserves x. Foreign development grants and other grants xi. Exchange rate depreciation xii. Ratio of non-tax revenue raised by the provincial government to GDP

Example of Revenue Assumptions – 1 Federal transfers from the divisible pool of tax revenue Assumptions: • The 7 th NFC award formula for distribution of divisible pool of tax revenue between the federal and provincial governments will be unchanged in the forecast period. • Real GDP growth and inflation rate and tax-to-GDP ratio will be the same as given in the IMF 7 th review. • The divisible pool of taxes as a percentage of total taxes will be unchanged at its FY 2012/13 level.

Example of Revenue Assumptions – 2 Transfer Under Article 161 of the Constitution and Clause 5 & 6 of the NFC award • Excise duty on natural gas: The ratio of transfer on account of excise duty on natural gas to total taxes will remain unchanged at the FY 2012/13 level. • Development surcharges and royalties: Development surcharges and royalties as a ratio of taxes are assumed to remain constant at the FY 2012/13 level. • Excise duty on oil: There was no excise duty on oil in the base year, FY 2012/13, and therefore no transfer on account of excise duty on oil. We assume that this status will be unchanged during the forecast period.

Example of Revenue Assumptions – 2 continued. . Transfer Under Article 161 of the Constitution and Clause 5 & 6 of the NFC award • Profit from hydro-electricity generation: • In FY 2012/13 Punjab received Rs 5. 1 billion as profit from hydro-electricity generation. • In order to have a claim on the federal government the Punjab government continues to budget for this even though it has not received any transfer under this head since 2013. • We have assumed that federal transfers on account of hydro-electricity generation will be zero from 2014 till 2016 but the next NFC award will allow Punjab to receive its claim adjusted for inflation and arrears. • Therefore, we forecast that Punjab will receive Rs 10. 8 billion in FY 2016/17 on account of hydro profits, which will go up to Rs 11. 8 billion in FY 2019/20.

Forecasting Development Expenditure (DE) • For forecasting DE, we take as a starting point the projected public investment to GDP ratio as given in the Planning Commission Vision 2025 (Discussion Draft). • These figures are interpolated for 2014 and for 2016 to 2019 (see Table 2). • We assume that if the ratio of public investment to GDP goes up from 3. 9 in 2013, to for example 4. 3 in 2014, then the federal share of public investment in GDP will also go up by a factor of (4. 3/3. 9) = 1. 09 and so will the share of public investment of Punjab, Sindh and KP in the GDP. • We further assume that development expenditure is a constant proportion of total public sector investment in Punjab.

Table 2: Public Investment as percentage of GDP Financial Year 2013 2014 2015 2016 2017 2018 2019 2020 Public Investment (% of GDP) 3. 9 4. 3 4. 68 4. 76 4. 84 4. 92 5. 00

Forecasting Development Expenditure (DE) Under the above assumption, we show (in the following two slides) that the forecast for nominal DE for each year can be obtained by multiplying the following three terms: 1. Ratio of development expenditure in period t (as percentage of GDP) to development expenditure in period t-1 (as percentage of GDP) 2. Level of development expenditure calculated for period t-1 3. Nominal GDP growth factor or (1 + real GDP growth rate) × (1 + GDP deflator).

Forecasting Development Expenditure (DE) From the assumptions in slide #20, it follows that the target level of development expenditure in Punjab in 2014 at 2014 prices (DE 2014; 2014 prices) as a ratio of GDP in 2014 at 2014 prices (GDP 2014; 2014 prices) is: DE 2014; 2014 prices/GDP 2014; 2014 prices = (4. 3/3. 9) × [(DE 2013; 2013 prices/GDP 2013; 2013 prices] or DE 2014; 2014 prices/GDP 2014; 2014 prices = (1. 09) × [(DE 2013; 2013 prices/GDP 2013; 2013 prices] (1) From (1) the forecast level of development expenditure in Punjab in 2014 (at 2014 prices) can be written as: DE 2014; 2014 prices = 1. 09 × DE 2013; 2013 prices × (GDP 2014; 2014 prices / GDP 2013; 2013 prices) (2)

Forecasting Development Expenditure (DE) • Letting g 2013 -14 be the real GDP growth rate in FY 2013/14 over the previous year, and π2013 -14 be the rate of inflation (GDP deflator) over the same period, equation (2) can be expressed as: • DE 2014; 2014 prices = 1. 09 × DE 2013; 2013 prices × (1 + g 2013 -14) × (1 + π2013 -14) (3) • By substituting for DE 2013; 2013 prices using the data from the Punjab budget, and by substituting for (1 + g 2013 -14) × (1 + π2013 -14) using projections from IMF 7 th Review, we can obtain development expenditure in Punjab in 2014 at 2014 prices as: • DE 2014; 2014 prices = 1. 09 × 134 × [(1. 041) × (1. 07)] = Rs 163 billion (4) • The RHS is the product of the three terms mentioned in slide # 22.

Forecasting Noninterest Current Revenue Expenditure (CRE) •

Forecasting Disposal of Non-financial Assets • Following GFSM 2014, our definition of revenue does not include proceeds from disposal of non-financial assets and privatization. • However, provincial budget documents include such disposal of nonfinancial assets as part of general revenue receipts (GRR). • We take disposal of non-financial assets to be approximately equal to the ‘extraordinary receipts’ in the budget documents. • The disposal of non-financial assets are assumed to remain unchanged in real terms at their base year level of FY 2012/13.

Forecasting Net Policy Lending (NPL) • Government policy lending can be “for a variety of reasons, such as fostering new industries, assisting ailing government corporations, or helping particular businesses suffering economic adversity. ” (GFSM 2014 P. 78). • We treat policy lending as loans that are extended by the provincial government to ‘local governments, financial institutions and autonomous bodies under its purview for meeting their current and development expenditures’. • Policy lending and repayments on policy lending are assumed to grow at the same rate as nominal GDP.

Forecasting Cash Reserves, Debt, Interest Income and Interest Expense • Having obtained forecast values of non-interest revenue receipts, non-interest CRE, disposal of non-financial assets and NPL, we calculate: • Interest income in Year 1 as: Interest income (in Year 1) = interest rate on cash reserves (in Year 1) × cash reserves (in Year 0) • Current revenue receipts (CRR) (in Year 1) as: CRR (in Year 1) = non-interest revenue receipts (in Year 1) + interest income (in Year 1) • General Revenue receipts (GRR) in Year 1 GRR (in Year 1) = CRR (in Year 1) + disposal of nonfinancial assets (in Year 1) • Interest expense (in Year 1) as: Interest expense (in Year 1) = interest rate on debt (in Year 1) × debt (in Year 0) • Current revenue expenditure (CRE) (in Year 1) as: CRE (in Year 1) = non-interest CRE (in Year 1) + interest expense (in Year 1) • Overall fiscal balance (OFB) in Year 1 as: OFB (in Year 1) = GRR (in Year 1) – DE (in Year 1) – CRE (in Year 1) – NPL (in Year 1) • Financing gap (in Year 1) as: Financing gap (in Year 1) = OFB (in Year 1) – debt repayment (in Year 1) • Adjusted financing gap (in Year 1) as: Adjusted financing gap (in Year 1) = financing gap (in Year 1) + minimum level of new foreign loans (in Year 1)

Forecasting Cash Reserves, Debt, Interest Income and Interest Expense • If adjusted financing gap is positive it is assumed that it adds to cash reserves. • If the adjusted financing gap is negative, it is assumed that: • it is first financed by accumulated cash balances • then by foreign debt, till foreign debt reaches an upper bound, and • the balance by domestic debt.

Forecasting Cash Reserves, Debt, Interest Income and Interest Expense • The sequence of financing described above, determines the level of cash reserves, and debt in Year 1. (Derived formally in the following slides). • Year 1 is the new base for the calculation of interest income on cash reserves and interest expense on debt for Year 2. • Forecasts for Year 2 follows the same steps as for Year 1. • Forecasts for each subsequent years is obtained similarly.

Determining Cash Reserves, New Foreign Loans and New Domestic Loans •

Foreign Debt • Foreign debt in each period is the sum of foreign debt in the previous period minus obligatory debt repayment in the current period plus new foreign loans. • As mentioned above, obligatory foreign debt repayment is assumed to equal the base year level of debt repayment in dollar terms. These are converted into rupee terms by multiplying by (1 + exchange rate depreciation). • The exchange rate is expected to depreciate by the difference between the domestic and foreign inflation rates. The former is obtained from IMF 7 th review and the latter is assumed to equal 2%. • New foreign loans are either the ‘default’ level or equal Ψt, or equal the upper bound (Γt) – the latter to be specified by the user/policy maker.

Domestic Debt • Domestic debt in each period is similarly the sum of domestic debt in the previous period, minus obligatory debt repayment in the current period plus new domestic loans. • Obligatory domestic debt repayment is assumed to equal either the base-year level of debt repayment or the outstanding debt, whichever is less. • New domestic loans are either zero or equal Ψt – Γt.

Concluding Comments • To recap: • Given base year values for cash reserves, foreign debt and domestic debt, OFB for Year 1 can be obtained from (5); • Given OFB for Year 1, values for cash reserves, domestic debt and foreign debt in Year 1 can be obtained from the assumptions on how the financing gap is met and sequencing of financing; • These values in turn help determine OFB in Year 2, which in turn determines cash reserves and debt in Year 2; • Thus, starting from base-year values of cash reserves, and domestic and foreign debt, we can determine OFB, cash reserves and debt in each subsequent year. • To get greater insight into the provincial budget, an excel-based tool has been developed (see references) that allows users to change the various assumptions made in the model and see their impact on revenue, spending, deficit and debt.

References Fatima, Umbreen. “Forecasting Tool for Punjab Revenue and Spending”. Available at: http: //ideaspak. org/people/item/277 -forecastinggovernment-revenue-and-expenditure/ Nasim, Anjum. "A Forecasting Model of Punjab Revenue and Spending". IDEAS Working Paper No. 02 -16 (July 2016). Available at: http: //ideaspak. org/images/Publications/Fiscal-Federalism/Forecasting -Punjab-Revenue-and-Spending. pdf