Budget FY25 & IMF’s conditions

The economic journey of Pakistan has recently showed a positive transformation, with macroeconomic indicators reflecting a promising outlook. The fiscal performance for the first nine months of the current fiscal year 2024-25 demonstrates significant progress, as the consolidated primary surplus has grown to Rs 3468 billion (2.8 percent of GDP) compared to Rs 1615 billion (1.5 percent of GDP) in the same period last year.

The budget deficit has also narrowed from Rs 3902 billion in 9 months of fiscal year (FY) 2024 to Rs 2970 billion in 9 months of FY2025, signaling improved fiscal management and financial discipline. The government’s efforts to adhere to fiscal consolidation and the monitoring mechanisms of the International Monetary Fund (IMF) have encouraged a semblance of stability, fostering cautious optimism in business communities and among individuals about a more growth-oriented tax regime in the coming fiscal year.

The financial appetite of the governments has sharply escalated over the past decade, as evidenced by an exponential rise in federal budget outlay from Rs 4.8 trillion in FY 2016-17 to Rs 18.8 trillion in FY 2024-25. An alarming rise in interest payments further exposes the underlying fiscal vulnerabilities. The interest payment component alone for the current fiscal year is nearly twice the size of the total federal budget from FY 2016-17, indicating a growing debt servicing liability that severely restricts fiscal space for development expenditure and social sector delivery.

The structural fiscal weakness, largely fueled by unproductive and mindless borrowing and inadequate tax reforms, continues to erode financial sovereignty. The government’s recurrent strategy to bridge fiscal gaps by raising taxes has imposed a disproportionate burden on both the business community and individual taxpayers. The budget for the current fiscal year is emblematic of this trend, featuring aggressive tax hikes aimed at achieving a historic tax collection target.

However, the actual tax collections have consistently fallen short, reflecting the regressive impact of such measures on economic activity. Over-reliance on compliant taxpayers, instead of widening the tax base, has contributed to persistent shortfalls and disincentivized formalization.

IMF’s influence on fiscal policy formulation in Pakistan has increased to an alarming level. Pakistan’s commitment to adhere to IMF conditions under the US$7 billion 37-month Extended Fund Facility (EFF) and additional support through Resilience and Sustainability Facility (RSF) requires a fundamental restructuring of economic governance. The latest tranche of nearly US$1 billion under the bailout package, as documented in IMF’s official review, came with 11 new structural benchmarks that will shape the country’s policy direction for the foreseeable future.

Parliamentary approval of 2026 budget in accordance with IMF guidelines forms the foundation of these new conditions. Alignment of budgetary priorities with programme targets will be critical to ensure macroeconomic stability. The implementation of agricultural income tax laws, through operational platforms for taxpayer registration, compliance frameworks, and communication strategies, is designed to capture revenue from a sector long exempted from meaningful taxation. Success of this measure is based on provincial cooperation, administrative capacity, and political will.

Publication of a governance action plan by October 2025, based on recommendations of the Governance Diagnostic Assessment, aims to address institutional weaknesses and enhance accountability. The action plan must go beyond symbolic commitments and present enforceable reforms that reduce leakages, strengthen procurement systems, and promote transparency in public financial management. The failure to address these governance gaps will undermine fiscal sustainability and erode public trust.

The annual inflation adjustment of Kafaalat unconditional cash transfer (UCT) programme by January 2026 is intended to protect the real purchasing power of the most vulnerable. Continuation of such social safety nets, while fiscally challenging, is essential for maintaining social cohesion and mitigating the adverse effects of structural reforms on low-income households. Limited fiscal space, however, raises concerns about the sustainability of such subsidies unless offset by real growth and efficient targeting.

The post-2027 financial sector strategy, to be prepared and published by June 2026, is another IMF’s condition aimed at safeguarding financial stability through institutional and regulatory reform. The banking sector’s resilience must be reinforced through enhanced oversight, capital adequacy norms, and frameworks for managing financial distress. In view of Pakistan’s history of undercapitalized banks and reliance on central bank support, this condition will demand sweeping reforms in banking governance and resolution mechanisms.

The energy sector, a longstanding fiscal drain, is also under IMF’s scrutiny. Notification of annual electricity and gas tariff adjustments by July 2025 and February 2026, respectively, will ensure that tariffs reflect cost-recovery levels. While these measures are economically rational, their implementation poses a severe affordability challenge for consumers. Continuation of cross-subsidies, inefficiencies in distribution companies (DISCOs), and rising circular debt further complicate the required reform.

Adoption of legislation to make Grid (Captive Power Plants) Levy Ordinance, 2025 permanent and to remove the cap on debt service surcharge by May and June 2025 respectively is geared towards incentivizing grid usage and ensuring financing for conversion operations. These reforms aim to rationalize energy consumption and promote efficiency but are likely to be met with resistance from industrial lobbies and consumers wary of rising costs.

Preparation of a comprehensive plan by December 2025 to phase out incentives in Special Technology Zones and other industrial parks by 2035 will test the government’s commitment to eliminating market distortions. While the objective is to promote fair competition and efficiency, the sudden withdrawal of incentives could dampen investor confidence unless accompanied by broader regulatory facilitation and support.

Submission of legislation to parliament by July 2025 to lift all quantitative restrictions on used vehicle imports, subject to environmental and safety standards, seeks to liberalize trade and reduce vehicle costs. The domestic automobile industry, however, is likely to lobby against this move, citing potential job losses and decline in local production. The government will need to balance industrial policy objectives with consumer affordability and trade liberalization commitments.

Failure to meet indicative targets (ITs) on health and education spending, net FBR revenue, and retail taxation under the Tajir Dost Scheme reflects ongoing implementation challenges. The chronic underinvestment in human capital continues to haunt Pakistan’s long-term development potential. Despite an expanding budget, allocations for health and education remain suboptimal, perpetuating cycles of poverty and underdevelopment. IMF’s conditionalities, though necessary for fiscal rectitude, risk squeezing development expenditure further unless structural reforms generate sufficient fiscal space.

The upcoming FY 2025-26 presents a formidable challenge. The agreed revenue target of Rs 14.3 trillion represents a 16 percent increase over the current downward revised target of Rs 12.3 trillion. While authorities remain optimistic about achieving this goal through natural revenue growth stemming from inflation and GDP growth, the IMF estimates that only half of this increase around Rs one trillion can be expected from such organic factors. The remainder must be realized through additional revenue measures, leaving limited room for tax relief or structural incentives.

The emphasis must shift toward innovative revenue mobilization strategies that broaden the tax base without overburdening compliant taxpayers.Untaxed segments, particularly in agriculture, retail, and real estate, must be brought into the formal net through data integration, enforcement, and policy consistency. Technological advancements such as digital tracking, data analytics, and inter-agency coordination offer promising avenues for enhancing compliance and transparency. The Federal Board of Revenue (FBR) must modernize its operations, reform its incentive structures, and depoliticize enforcement to regain credibility. The geopolitical environment has added another layer of complexity to budgetary planning.

The recent flare-up of hostilities with India has increased the necessity for defence preparedness. According to Stockholm International Peace Research Institute (SIPRI), Pakistan’s military expenditure constitutes 2.67 percent of GDP higher than India’s 2.27 percent in relative terms. However, in absolute financial terms, Pakistan’s defense budget of US$ 7.6 billion is dwarfed by India’s US$75 billion allocation.

This disparity highlights the need for strategic spending rather than sheer expansion rendering the balancing act between national security and social investment, increasingly tenuous.

The persistent allocation of a large share of resources to defence, coupled with spiraling debt servicing costs, has left little room for transformative investments in education, health, and infrastructure. The current situation on both sides of the border demands urgent reorientation of priorities. The regional leadership, supported by the international community, must recognize that sustainable peace and economic development are mutually reinforcing. Time has come to divert resources from arms races to human capital development, benefiting the combined 1.7 billion population of the region.

The challenges facing implementation of IMF benchmarks are complex. Political instability, bureaucratic inertia, elite resistance, and institutional capacity constraints have historically hindered reform execution. The frequent changes in political leadership add uncertainty to the continuity of policy commitments. The credibility of Pakistan’s reform narrative depends not only on meeting targets but on ensuring institutionalization of reforms beyond IMF’s supervision.

The IMF’s oversight, while often viewed as intrusive, has imposed a discipline that domestic policymaking lacked. Successful adherence to the 11 new structural benchmarks will not only unlock further tranches but also signal to global markets and investors that Pakistan is on a path of sustainable fiscal and economic governance. The failure to deliver, however, could reverse modest gains and push the country into another cycle of crisis and bailout.

The way forward is clear. Pakistan must embrace difficult reforms, not as conditions imposed by an external entity, but as necessary correctives for systemic incompetence and unsustainable practices. The upcoming budget for FY 2025-26 must reflect this philosophy by shifting from revenue extraction to facilitative growth, from defense-centric allocation to human capital investment, and from ad-hoc policymaking to institutional governance.

The window for reform is narrow, but the cost of inaction is exponentially high. The nation stands at a crossroads, and the decisions taken now will shape its economic destiny for generations. The choice between populism and pragmatism, between crisis and consolidation, lies in the hands of its policymakers.

Copyright Business Recorder, 2025