The macroeconomics of public sector deficits : the case of Pakistan

For almost twenty years, Pakistan's fiscal deficit, at about 7 percent of GNP, averaged nearly twice the level for Asian countries as a whole. This paper examines the causes of Pakistan's fiscal deficits. The authors examine why, despite these deficits, the country's macroeconomic performance has been surprisingly good. The equilibrium deficit is estimated to have been quite high in recent years (about 5.5 percent of GNP), despite a low inflation rate, because of a very high underlying rate of growth of real output (about 6 percent a year). This allowed a fairly rapid expansion of debt without recourse to inflationary finance. To gain additional insight into the role of fiscal deficit in Pakistan, the authors analyze how alternative fiscal policies would have affected the country's economic performance during the 1980s. They find that : i) reducing the deficit by cutting public expenditure could have had a favorable effect on the trade balance, but at a cost to economic growth and with few price payoffs; ii) increasing tax revenues could achieve a similar external adjustment while reducing the output cost; and iii) altering the composition of deficit financing would have predictable results - shifting to more money financing would mean higher prices, lower interest rates, and higher growth.