1. Forecasting Punjab Revenue and Expenditure
Anjum Nasim
May, 2017

2. 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

3. 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 30th, is also placed before the respective assemblies as part of the budget.
Constitutionally ABS is also part of the finance bill.
The constitution also mentions local government as another tier of government. each province should establish a local government system and devolve political, administrative and financial responsibility and authority to the elected representatives of the local government. The extent of such devolution is to be found in the local government bills passed by the provinces.

4. 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.
The federal/provincial government, defined in the Constitution as the Prime Minister/Chief Minister and the cabinet ministers, is responsible for all governmental affairs.

5. 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.

6. 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).
For further explanation of the terms used in Table 1 see Nasim (2016).

7. Table 1: General Abstract of Receipts and Expenditures
General Revenue Receipts (GRR)
Federal transfers (including excise duty on natural gas)
Provincial tax revenue
Provincial non-tax revenue
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

8. Methodology of the White Paper
The White Paper calculates:
surplus and deficit on revenue account and capital account
surplus for development expenditure or resources available for development
Surplus/resources available for development expenditure:
=(GRR + GCR) – CRE + CCE
=(GRR – CRE) + (GCR – CCE)
=Net revenue account surplus/deficit + Net capital account surplus/deficit
= A+B
Development expenditure (DE) is then matched with the available resources (A + B).

9. 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 FY2008/09.
In our paper we will not concern ourselves with the Public Accounts of the provincial budget.

10. 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 7th 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.

11. Forecasting Methodology- Nasim, 2016 How it differs from MTFF
Our forecasting approach differs from that followed in the Medium Term Fiscal Framework to (MTFF) of the Punjab government.
The MTFF forecasting framework involves:
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)
forecasting the level of current expenditures
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.

12. 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 Year1 as product of cash reserves in the base year and interest rate in Year1 – reported in the budget as a non-development grant of the federal government
interest expense in Year1 as product of debt in the base year and interest rate in Year1

13. Forecasting Methodology- Nasim, 2016
We then calculate:
Current Revenue Expenditure (CRE) in Year1 as the sum of non-interest current expenditure in Year1 and interest expenditure in Year1
General Revenue Receipts (GRR) in Year1 as the sum of non-interest revenue receipts in Year1, interest income in Year1 and disposal of non-financial assets in Year1
Overall Fiscal Balance (OFB) in Year1 by subtracting DE, CRE and NPL (in Year1) from GRR in Year1
Financing Gap in Year1 by subtracting debt repayments in Year1 from OFB in Year1
Adjusted Financing Gap in Year1 by adding a minimum level of foreign loans in Year1 to the financing gap in Year1 (by assuming the government will always tap into available low cost foreign financing).

14. 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 Year1 and debt in Year1.
Treating Year1 as the base, we can forecast interest income and interest expense in Year2, and consequently total revenue and total spending in Year2.
Forecasts for each subsequent year are obtained similarly.

15. Forecasting Non-interest Revenue Receipts
We break down non-interest revenue into five categories:
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 for examples).
Taken together, we make assumptions on variables listed in the following slide.
Non-Tax revenues are revenues from regulatory and economic functions

16. Forecasting Non-interest Revenue Receipts
We make assumptions about the following variables:
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
Provincial share in total taxes and Punjab’s share in the provincial tax revenue
Ratio of excise tax to total tax
Transfers on account of hydro-electricity profits
Ratio of royalties and development surcharges to total taxes
Non-development grants other than cash reserves
Interest rate on cash reserves
Foreign development grants and other grants
Exchange rate depreciation
Ratio of non-tax revenue raised by the provincial government to GDP

17. Example of Revenue Assumptions – 1
Federal transfers from the divisible pool of tax revenue
Assumptions:
The 7th 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 7th review.
The divisible pool of taxes as a percentage of total taxes will be unchanged at its FY2012/13 level.

18. 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 FY2012/13 level.
Development surcharges and royalties: Development surcharges and royalties as a ratio of taxes are assumed to remain constant at the FY2012/13 level.
Excise duty on oil: There was no excise duty on oil in the base year, FY2012/13, and therefore no transfer on account of excise duty on oil. We assume that this status will be unchanged during the forecast period.

19. 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 FY2012/13 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 Rs10.8 billion in FY2016/17 on account of hydro profits, which will go up to Rs11.8 billion in FY2019/20.

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 (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) = 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.

21. 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
4.6
4.68
4.76
4.84
4.92
5.00

22. 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:
Ratio of development expenditure in period t (as percentage of GDP) to development expenditure in period t-1 (as percentage of GDP)
Level of development expenditure calculated for period t-1
Nominal GDP growth factor or (1 + real GDP growth rate) × (1 + GDP deflator).

23. 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 (DE2014; 2014 prices) as a ratio of GDP in 2014 at 2014 prices (GDP2014; 2014 prices) is: DE2014; 2014 prices/GDP2014; 2014 prices = (4.3/3.9) × [(DE2013; 2013 prices/GDP2013; 2013 prices] or DE2014; 2014 prices/GDP2014; 2014 prices = (1.09) × [(DE2013; 2013 prices/GDP2013; 2013 prices] (1) From (1) the forecast level of development expenditure in Punjab in 2014 (at 2014 prices) can be written as: DE2014; 2014 prices = 1.09 × DE2013; 2013 prices × (GDP2014; 2014 prices / GDP2013; 2013 prices) (2)

24. Forecasting Development Expenditure (DE)
Letting g be the real GDP growth rate in FY2013/14 over the previous year, and π be the rate of inflation (GDP deflator) over the same period, equation (2) can be expressed as:
DE2014; 2014 prices = 1.09 × DE2013; 2013 prices × (1 + g ) × (1 + π ) (3)
By substituting for DE2013; 2013 prices using the data from the Punjab budget, and by substituting for (1 + g ) × (1 + π ) using projections from IMF 7th Review, we can obtain development expenditure in Punjab in 2014 at 2014 prices as:
DE2014; 2014 prices = 1.09 × 134 × [(1.041) × (1.07)] = Rs163 billion (4)
The RHS is the product of the three terms mentioned in slide # 22.

25. Forecasting Noninterest Current Revenue Expenditure (CRE)
We assume that the non-interest component of CRE would increase at the same real rate at which it grew during the period FY2008/09 to FY2012/13 or 8%.
The nominal growth factor of CRE is then obtained by multiplying the real growth factor (1.08), by the CPI inflation factor (1 + 𝑃 ).

26. 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 non- financial 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 FY2012/13.

27. 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 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.

28. 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 Year1 as:
Interest income (in Year1) = interest rate on cash reserves (in Year1) × cash reserves (in Year0)
Current revenue receipts (CRR) (in Year1) as:
CRR (in Year1) = non-interest revenue receipts (in Year1) + interest income (in Year1)
General Revenue receipts (GRR) in Year1
GRR (in Year1) = CRR (in Year1) + disposal of nonfinancial assets (in Year1)
Interest expense (in Year1) as:
Interest expense (in Year1) = interest rate on debt (in Year1) × debt (in Year0)
Current revenue expenditure (CRE) (in Year1) as:
CRE (in Year1) = non-interest CRE (in Year1) + interest expense (in Year1)
Overall fiscal balance (OFB) in Year1 as:
OFB (in Year1) = GRR (in Year1) – DE (in Year1) – CRE (in Year1) – NPL (in Year1)
Financing gap (in Year1) as:
Financing gap (in Year1) = OFB (in Year1) – debt repayment (in Year1)
Adjusted financing gap (in Year1) as:
Adjusted financing gap (in Year1) = financing gap (in Year1) + minimum level of new foreign loans (in Year1)

29. 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.

30. Forecasting Cash Reserves, Debt, Interest Income and Interest Expense
The sequence of financing described above, determines the level of cash reserves, and debt in Year1. (Derived formally in the following slides).
Year1 is the new base for the calculation of interest income on cash reserves and interest expense on debt for Year2.
Forecasts for Year2 follows the same steps as for Year1.
Forecasts for each subsequent years is obtained similarly.

31. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
We have defined OFB as the difference between GRR and the sum of CRE, DE and NPL :
𝑂𝐹𝐵 𝑡 = 𝐺𝑅𝑅 𝑡 – 𝐶𝑅𝐸 𝑡 – 𝐷𝐸 𝑡 – 𝑁𝑃𝐿 𝑡 (5)
Define 𝛷 𝑡 as:
𝛷 𝑡 = 𝑂𝐹𝐵 𝑡 − 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 − 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 (6)
𝛷 𝑡 is the financing gap, which is determined if values of the RHS variables in (6) were known.
As mentioned earlier, OFB for Year1 can be determined from (5) but to determine values for subsequent year, we will have to determine values for cash reserves and domestic and foreign debt. To determine the other variables on the RHS of (6) (domestic and foreign debt repayment), we make the following assumptions:
There is no premature domestic debt retirement and the only domestic debt that the government must retire is the debt that it is obligated to retire under the terms of the contract. Further, the annual domestic nominal debt retirement will either be the same as in FY2012/13 (Rs18 billion) or the nominal debt outstanding, whichever is less.
Foreign debt retirement in each of the forecast periods will be unchanged in dollar terms from the FY2012/13 level. (The foreign debt repayment in the base year in rupee terms was Rs12.6 billion).

32. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
The financing gap 𝛷 𝑡 in (6) is modified by taking into account, what we term the default level of new foreign loans.
We assume that there is a minimum level of new foreign loans that the government undertakes each year to take advantage of concessionary foreign lending.
Domestic loans, on the other hand, are expensive and the government will turn to these when other sources of financing have been exhausted (see below).
The default level of new foreign loans are assumed to remain unchanged, in dollar terms, from their base year value.

33. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
Let ϴt be the financing gap after taking into account the default level of foreign loans:
𝛳 𝑡 = 𝑂𝐹𝐵 𝑡 − 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 − 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 + (𝑑𝑒𝑓𝑎𝑢𝑙𝑡 𝑙𝑒𝑣𝑒𝑙 𝑜𝑓 𝑛𝑒𝑤 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑙𝑜𝑎𝑛𝑠) 𝑡 (7)
If the RHS in (7) is positive, it is treated as net addition to cash reserves. If it is negative, it can be financed by:
accumulated cash reserves
new foreign loans (over and above the default level)
new domestic loans

34. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
In our model, if 𝛳 𝑡 is negative, the gap is first met by running down cash reserves.
Once these are exhausted the government turns to foreign loans that would now exceed the default level.
New foreign loans also have an upper bound Γt.
Once the upper bound Γt is reached, the relatively more expensive domestic loans kick in and the balance is met from domestic borrowing.

35. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
Now adding accumulated cash reserves from the past to the adjusted financing gap, ϴt, we obtain Ωt:
Ω 𝑡 = 𝐶𝑅 𝑡−1 + 𝛳 𝑡 (8)
Cash reserves are restricted to be non-negative, so that CRt equal Ωt if Ωt is non-negative and zero otherwise:
CRt = Ω 𝑡 if Ω 𝑡 ≥0; CRt = 0 if Ω 𝑡 <0 (9)
Once all cash reserves are exhausted ( Ω 𝑡 <0), the government turns to additional foreign loans that would now exceed the default level.

36. Determining Cash Reserves, New Foreign Loans and New Domestic Loans
New foreign loans also have an upper bound Γt.
New foreign loans (Ψt), when they exceed the default level but do not exceed the upper bound Γt, take the following form:
𝛹 𝑡 = 𝑑𝑜𝑚𝑒𝑠𝑡𝑖𝑐 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 + 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑑𝑒𝑏𝑡 𝑟𝑒𝑝𝑎𝑦𝑚𝑒𝑛𝑡 𝑡 − 𝐶𝑅 𝑡−1 +𝑂𝐹𝐵 𝑡 (10)
Once the upper bound Γt is reached, the relatively more expensive domestic loans kick in and the balance is met from domestic borrowing.
New domestic loans then equals Ψt – Γt.

37. 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 7th 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.

38. 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.

39. Concluding Comments To recap:
Given base year values for cash reserves, foreign debt and domestic debt, OFB for Year1 can be obtained from (5);
Given OFB for Year1, values for cash reserves, domestic debt and foreign debt in Year1 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 Year2, which in turn determines cash reserves and debt in Year2;
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.

40. References
Fatima, Umbreen. “Forecasting Tool for Punjab Revenue and Spending”. Available at: government-revenue-and-expenditure/ Nasim, Anjum. "A Forecasting Model of Punjab Revenue and Spending". IDEAS Working Paper No (July 2016). Available at: Federalism/Forecasting-Punjab-Revenue-and-Spending.pdf