Pakistan: Under IMF’s watchful eyes, government unveils ambitious FY24 budget ahead of elections

• The government sets a moderate GDP growth target of 3.5% y/y for FY24; inflation seen easing to 21% y/y
• Gross revenue projected to expand to PKR 12.2tn, which has been termed 'unrealistic' as no new major taxes imposed
• Higher debt servicing, jump in public employees' salaries and record development spending to jack up total expenditure by 30.4% y/y to PKR 14.5tn
• Fiscal deficit pegged at 6.5% of GDP for next fiscal year, down from an estimated 7% in FY23
• The government aims to raise USD 1.5bn from global bond issuances, USD 4.5bn from foreign commercial banks, USD 3bn in fresh deposits and USD 2.4bn from the IMF in FY24
• The budget is unlikely to convince the IMF to disburse the last loan tranche; government to initiate debt restructuring talks with bilateral creditors

The federal government on June 9 unveiled an expansionary budget for FY 2023-24, perhaps keeping in mind the upcoming general election. Millions of government employees were appeased by sharply increasing their salaries and other benefits while FinMin Ishaq Dar claimed that no new taxes were imposed in the budget. "The government has tried to provide as much relief as possible," he said during his budget speech. Moreover, development expenditure is estimated to expand by a third to a record high in the next fiscal year - probably another election gimmick to kickstart projects in an effort to gain political capital.

The budget is unlikely to impress the IMF that was keenly watching the fiscal targets proposed for FY24 to determine if the long-pending loan tranche should be disbursed and help the country avoid an imminent sovereign default. However, Dar said that he had presented a "responsible budget", instead of an election or political budget, adding the global lender should not have any problem with it.

The proposed budget is likely to sail through the parliament without any resistance given the absence of opposition in the house.

Macroeconomic framework

The government has set a moderate GDP growth target of 3.5% y/y for FY24 despite a low base as the economy is estimated to have expanded by just 0.3% y/y in FY23 on account of fiscal consolidation, higher cost of living and borrowing and the impact of last year's devastating floods. In his post-budget press conference, FinMin Ishaq Dar termed the target "not unrealistic", adding record public development spending would drive the growth.

Nevertheless, the GDP growth outlook is subject to several downside risks, including tight monetary policy and elevated inflation, which are likely to keep private investment and consumption anaemic. Moreover, continuation of stringent import curbs - in case the government fails to reach an agreement with the IMF on ninth review, which is a real possibility - would be a negative for industrial output.

Meanwhile, a fresh IMF loan programme presents another stark risk to the growth forecast as the bailout package, to be negotiated by the new elected government, would likely require expenditure cuts, including development spending, further taxation measures and currency depreciation, among others, thus, ultimately affecting the economic activity in the country.

On the price front, the government projected CPI inflation to remain elevated at 21% y/y in FY24 but to decelerate from 29% y/y in the ongoing fiscal year, probably due to beneficial base effect, easing of global commodity prices and relatively stable exchange rate. Inflation was seen decelerating to the medium-term target of 5%-7% by FY26.

On the external front, Pakistan's current account deficit was pegged at 6% of GDP in FY24, up from an estimated 3.7% in the current fiscal year partly on account of expansion in goods trade deficit as a rise in exports is offset by higher imports.

Lastly, public debt was forecast to decline from 73.7% of GDP at end-FY23 to 66.5% at the end of FY24 solely because of a surge in nominal GDP growth as the debt in absolute terms was seen rising by about PKR 8tn y/y to PKR 71tn at end-FY24 on the back of an increase in both external (8% y/y to PKR 27tn) and domestic (15.8% y/y to PKR 44tn) debt.

Overall, the government's GDP growth and inflation estimates are in line with the IMF's April projections. On the other hand, overall fiscal deficit and public debt forecasts are quite optimistic than that of the global lender, which predicted the budget gap to climb to 8.3% of GDP in FY24 while public debt was pegged at 68.9% at end-FY24. Meanwhile, the IMF's projection of 2.4% of GDP for the country's current account deficit was quite upbeat than the government's estimate.

Federal Government Budget

Revenue receipts

A revenue target of PKR 12.2tn has been set for FY24, which has been deemed "unrealistic" by some analysts. The target is PKR 3.3tn or 37.9% higher than the revised estimates (RE) of FY23. The bulk of this expansion would come on the back of tax revenue, which is collected by the Federal Board of Revenue (FBR). The agency is given the target of collecting PKR 9.2tn in tax revenue in the next fiscal year compared to PKR 7.2tn that is expected to be mopped up this year (thus, missing its revised target of PKR 7.64tn).

According to budget documents, about PKR 1.76tn of the PKR 2tn increase in tax revenue would accrue on account of inflation and GDP growth while the remaining PKR 223bn would be generated through new revenue measures, of which about four-fifth is expected to flow from income tax.

The government retained all taxes introduced in the supplementary budget unveiled in February, which would help it generate over PKR 500bn in revenue in FY24. Similarly, the one-time super tax imposed last year on wealthy individuals (between 1% and 4%) and high-earning industries (10%) will remain in place this fiscal year as well.

Meanwhile, non-tax revenue has been pegged at nearly PKR 3tn in FY24, some 83.1% higher than the RE of FY23. About two-third of the non-tax revenue is estimated to be collected from petroleum development levy and as surplus profit of the State Bank of Pakistan (SBP).

Meanwhile, the federal government will transfer funds worth PKR 5.3tn (up 27.8% y/y) to the four provinces from the divisible pool taxes in FY24. As a result, its net revenue is projected to be PKR 6.9tn in the next fiscal year.

Expenditure

The size of the federal budget is estimated at PKR 14.5tn in FY24, up sharply by PKR 3.4tn or 30.4% from RE of FY23, hence some analysts termed it a "populist budget" ahead of the general elections later this year.

Current expenditure has been budgeted at PKR 13.3tn, of which about 55% or PKR 7.3tn alone going towards debt servicing. In other words, the federal government's income after transferring funds to the provinces is not even sufficient to finance its debt repayments. Similarly, another 12.5% of the total expenditure has been allocated for defence as the government aims to spend PKR 1.8tn on it in FY24, which is around 13.7% higher than the RE of FY23. The allocation is along expected lines given higher military needs amid renewed surge in terrorist attacks by Islamist groups and Baloch separatists.

However, the allocation for defence services does not give a full picture of the actual amount the government would be spending on the armed forces. For instance, of PKR 761bn funds earmarked for pension (up 25% y/y), PKR 563bn would be paid to the retired military personnel, which would come from the civilian government's coffers instead of the defence budget. Moreover, there is also lack of transparency around the expenses incurred on import of military hardware and running of the country's nuclear programme.

Further, the government's spending on pension has crossed its expenditure on the running of the civil administration, which is projected at PKR 714bn in FY24, up by 29% from RE of FY23 largely because of up to 35% jump in salaries of public employees.

On the other hand, the government has earmarked PKR 1.1tn in subsidies for FY24, down by 2.6% y/y from RE of FY23 - the only move that could appease the IMF. Significant cuts have been made to subsidies for power and petroleum sectors.

Further breakdown of the current expenditure shows that the government has budgeted PKR 24.2bn for the health sector in FY24, a meagre rise from PKR 22.5bn spent in the outgoing fiscal year. Spending on the education sector will also see insignificant growth of 5.8% y/y to PKR 97.1bn in the next fiscal year, with nearly four-fifth of the budgeted amount allocated for tertiary education. The government will also provide PKR 1.5tn in grants to provinces, ministries and departments. Of this, PKR 450bn has been budgeted for Benazir Income Support Programme (BISP) while PKR 280bn will be given as sovereign guarantees on behalf of the public sector enterprises.

Meanwhile, the government increased its development expenditure under the so-called Public Sector Development Programme (PSDP) to PKR 950bn in FY24, up markedly from about PKR 500-550bn (the budget document wasn't much clear about it) spent in this fiscal year as FinMin Ishaq Dar said that public investment will be the main engine of growth in the next fiscal year. The development of physical infrastructure such as roads, dams, power plants etc received the highest priority as PKR 491bn or more than half of the PSDP has been allocated for it. Another PKR 241bn or 25% of the programme has been budgeted for social development (building of hospitals, school etc). To note, if we include PKR 200bn that the government allocated for the execution of public-private projects, then the total development spending reaches a record high of PKR 1.14tn in the next fiscal year.

It is noteworthy that in FY23 budget, the government had set a PKR 727bn target for public investment, but managed to disburse much below this figure as it had to curtain its development spending in a bid to rein in the fiscal deficit. A similar scenario can take place this fiscal year as well, considering Pakistan will seek to enter into a new IMF bailout package later this year. Analysis of the previous budgets show that actual development spending has almost always fell short of budgeted amount.

Budget deficit/financing

The federal government fiscal deficit has been projected at an all-time high of PKR 7.6tn in FY24 compared to an estimated PKR 6.4tn in FY23. This will be partially offset by an anticipated PKR 650bn provincial cash surplus, thus bringing the general government fiscal deficit to PKR 6.9tn. The budget gap is forecast to equal 6.5% of GDP in the next fiscal year, down from 7% in the outgoing fiscal year (which was originally budgeted at 4.9%).

On the other hand, the primary budget balance - a key indicator for the IMF - has been targeted to post a PKR 380bn surplus (0.4% of GDP) in FY24. A similar ambitious target was fixed for the current fiscal year, but the government missed it with a wide margin. Against the target of PKR 153bn (0.2% of GDP) surplus, the primary balance registered a deficit of PKR 421bn (0.5% of GDP) in FY23.

The federal fiscal deficit is expected to be financed through net PKR 5tn domestic loans, net PKR 2.5tn external loans while PKR 15bn is targeted to be generated from privatization of state-owned assets.

The foreign borrowing projections for FY24 are USD 24bn, which are 114% higher than the inflows recorded this year. The government expects a total of USD 5bn in inflows from Saudi Arabia, including rollover of USD 3bn current deposits and USD 2bn fresh deposit. Another USD 1bn deposits are expected from the UAE. It also plans to raise USD 1.5bn from global bond issuances, USD 4.5bn from international commercial banks, and USD 4bn from China's SAFE deposit, which is almost double the amount received from the key ally this fiscal year.

Budget unlikely to satisfy IMF, govt to initiate 'Plan B'

Although the government seeks to secure the next (and final) loan tranche of about USD 1.1bn under the IMF's Extended Fund Facility, there is a consensus in the market that it is unlikely to happen, given the expansionary nature of the budget. A fiscally responsible budget was one of the three measures necessary to strike an agreement with the global lender, which would have released some of the USD 2.5bn still pending under the programme that ends this month. The other two conditions - securing external financing commitment for USD 6bn and allowing forex market to function properly - are unmet as well, dimming the hopes that the IMF would release the funds and increasing the likelihood of Pakistan defaulting on its external debt.

Having said that, perhaps the government already envisioned this scenario when FinMin Ishaq Dar told a media briefing last week that an alternative plan is in place in case no deal is reached with the IMF on the ninth review. A component of the so-called 'Plan B' was revealed by Dar during his post-budget press conference. He said the country was considering asking its bilateral partners for debt restructuring, clarifying that the talks would not include "haircuts or write-offs". That would certainly provide a major relief to the South Asian nation as bilateral creditors made up USD 37bn of its total foreign debt at end-June 2021, out of which USD 23bn is owed to China, according to an IMF country report released in September last year.

Furthermore, the budget documents show no inflows from the IMF for the remainder of this fiscal year, i.e., in June. This is another indication that the government actually does not see a staff-level agreement over the ninth review and the subsequent disbursement of funds.

Irrespective of whether or not Pakistan receives any more funds under the current IMF loan programme, it is set to initiate negotiations with the lender for a fresh bailout package later this year to avert a balance of payments crisis. The political party/parties that will form the government following the general election due in October/November will do so. The fiscal performance of the government in the first months (or half) of the next fiscal year would determine how tough the negotiations would be. Overall, the government expect to receive USD 2.4bn from the IMF as budgetary support in FY24.

Fiscal policy changes/salient features of FY24

Enhancement of IT sector's exports

• Concessionary fixed income tax rate of 0.25% on exports of Information Technology and Information Technology Enabled Services (IT and ITeS) to continue for tax years 2024, 2025 and 2026
• Banks' earning from advances to the IT sector (as well as to the construction and agriculture sectors and SMEs) to be taxed 20% instead of standard rate of 39% in a bid to incentivize the lenders to increase loans to the sector
• Exporters of IT and ITeS will be allowed duty free import of IT related equipment equivalent to 1% value of their export proceeds

Renewable energy

• Custom duties on import of raw material used for manufacturing of solar panels, inverters and batteries have been scrapped to accelerate the country's shift to renewable energy
• The use of inefficient fans and incandescent bulbs has been discouraged by imposing tax on the import of such items

Steps to boost forex inflow/discourage forex outflow

• Those who send money from outside Pakistan up to USD 100,000 (about PKR 30mn) will not be asked any questions on their source of income/assets. Previously, the limit was PKR 5mn.
• The government also hiked withholding tax rate from 1% to 5% on payments to "non-residents through debit/credit or prepaid cards" to discourage forex outflow from the country
• Withholding tax of 2% on purchase of immovable property for non-resident Pakistanis have been waived, provided that the sale is made through money remitted from abroad

Promotion of digital payments

• The government reduced services tax on restaurants from 15% to 5% if the payment is made through a digital channel, i.e., debit/credit cards, mobile wallets or QR scanning. This means dining out will get cheaper if one opts for electronic payment methods.

Relief to low-income households/government employees

• Budget allocation for Benazir Income Support Programme (BISP) has been increased to PKR 450bn in FY24 from PKR 400bn in FY23. Under the programme, low-income individuals receive cash handouts, educational stipends and academic scholarships etc.
• A targeted subsidy of PKR 35bn selected items will be provided to the government-run utility stores in the next fiscal year
• Removal of regulatory duty on second hand clothing
• The government increased the minimum monthly wage for government employees to PKR 30,000 from PKR 25,000 while minimum pension for ex-government servicemen and women has been increased to PKR 12,000
• Wages of government employees from Grades 1-16 and Grades 17-22 to be increased by 35% and 30%, respectively

Other measures

• Banks are allowed to deduct advance tax at the rate of 0.6% of the cash withdrawal from individuals who are not in the active tax list (ATL) in an attempt to push people to file their income tax returns. The move, however, may be a negative for financial inclusion as depositors may pull out their money from bank accounts to avoid the tax.
• Used cars with engine capacity of over 1,300cc from Asian markets such as Japan are likely to get expensive as the government did away with caps on the fixed duties and taxes on the import of such vehicles
• Custom duties on import of seeds for sowing will be exempted to lower input cost for farmers
• A 10% withholding tax has been imposed on issuance of bonus shares by both listed and non-listed companies
• In a bid to protect local glass industry, regulatory duty on the import of various glass types have been doubled to 30%
• 100,000 laptops will be given to students which will cost the exchequer PKR 10bn in FY24

Conclusion

Overall, it appears that fiscal slippages are bound to take place again in FY24, given the unrealistic revenue target amid the lack of new substantial taxation measures. There will also be difficulty in accessing the proposed foreign loans at least initially when there would no IMF cover. This means that the new government that will come to power later this year may have to introduce supplementary budget (also known as mini-budget) during its negotiations with the IMF for a fresh bailout package that might see expenditure cuts, especially development spending, and additional revenue measures.