Comprehensive Analysis of Pakistan's Economic State and the FY25 Federal Budget

Comprehensive Analysis of Pakistan's Economic State and the FY25 Federal Budget

Pakistan’s economic situation and the Federal Budget for FY25 presents a nuanced view of the country’s economic landscape. This analysis integrates his observations on various macroeconomic indicators, fiscal strategies, and policy measures from different sectors there is a  comprehensive picture of the state of the economy and the challenges ahead.

1. Overview of the Economic Environment in FY24

1. GDP Growth:
   • The GDP growth rate turned positive in FY24, reaching 2.4%, up from a negative 0.2% in FY23. This growth, however, is not evenly distributed across sectors. The agricultural sector played a crucial role, with major crops recording an unprecedented growth rate of 16.8%, recovering strongly from the devastation caused by the floods in 2022-23.
   • Despite this agricultural rebound, the large-scale manufacturing (LSM) sector remained stagnant with zero growth. This stagnation is due to a decline in several key industries, including textiles, automobiles, and cement. These industries faced challenges such as restricted imports of essential inputs and reduced consumer demand.
2. Inflation Trends:
   • Inflation showed a significant decline in FY24, dropping from 38.3% in May 2023 to 11.8% in May 2024. This reduction was primarily due to the 'high base effect' from the previous year. However, despite the overall decline, the Sensitive Price Index (SPI) continued to reflect high inflation rates of over 21%, indicating persistent inflationary pressures in essential goods.
   • The average inflation rate for FY24 is expected to be around 23%, with food prices having risen by 69% since 2021-22. This has severely impacted the living conditions of the population, reducing real per capita income by over 2% and increasing poverty levels.
3. Fiscal Deficit and Public Debt:
   • The fiscal deficit for FY24 is projected to be around 7.4% of GDP, up from the initial target of 6.5%. The revised estimate, which typically understates the actual deficit, suggests that the final figure could approach 8%, with a small primary deficit. This increase is attributed to high debt servicing costs and the inability to control current expenditures effectively.
   • The public debt burden continues to rise, with debt servicing accounting for a significant portion of the budget. In FY25, the total cost of debt servicing is expected to increase by 18%, reflecting the impact of high policy rates and large borrowings.
4. External Balance and Foreign Exchange Reserves:
   • The current account deficit for FY24 is near zero, supported by a 5% contraction in imports and an over 10% increase in exports. Foreign exchange reserves have stabilized at around $9 billion due to improved trade balance and financial account inflows, including a $2.2 billion net inflow from the IMF's Stand-by Facility.
   • However, the financial account of the balance of payments saw a turnaround, with a positive balance of $4.2 billion compared to a negative $1.2 billion in FY23. This was primarily due to a net inflow of loans and deposits of $2.6 billion. Despite these improvements, maintaining stability in foreign reserves remains a challenge due to the high external financing needs.

2. Key Features and Ambitious Targets of the FY25 Budget

1. Revenue Projections:
   • The Federal Board of Revenue (FBR) has set an ambitious target of increasing revenues by 40% from Rs 9.3 trillion to almost Rs 13 trillion in FY25. This includes a 48% increase in direct taxes and a 35% increase in indirect taxes, with the tax-to-GDP ratio expected to rise from 8.7% to 10.4%.
   • Non-tax revenues are also expected to grow significantly, by 64%, driven primarily by an anticipated 157% increase in SBP profits, from Rs 927 billion in FY24 to Rs 2,500 billion in FY25. These projections are seen as overly optimistic, given the lack of detailed breakdowns and the historical performance of these revenue streams.
2. Expenditure Allocations:
   • The budget proposes a 21% increase in current expenditures, significantly above the expected rate of inflation. Key components include a 22-25% increase in salaries and pensions, and a 51% increase in debt servicing costs. There is also a planned 20-27% increase in grants and subsidies, reflecting the government's commitment to maintaining social spending despite fiscal constraints.
   • The Public Sector Development Programme (PSDP) is set to double, focusing on critical sectors such as energy (212% increase), water resources (106% increase), and physical planning and housing (102% increase). However, the Higher Education Commission (HEC) receives only a 10% increase, indicating a limited focus on human capital development.
3. SOEs and Defence Spending:
   • State-Owned Enterprises (SOEs) continue to impose a heavy burden on the budget, with total allocations expected to increase by over 52% to Rs 1848 billion in FY25. This includes a 104% increase in subsidies, primarily aimed at controlling the power sector's circular debt, and additional allocations for contingent liabilities and grants.
   • Defence expenditure is also set to increase by 18%, reaching Rs 3101 billion, which is 2.5% of GDP and the second-largest budgetary allocation after debt servicing.
4. External Financing and Debt Management:
   • The total external financing requirement for FY25 is estimated at $24 billion, including $15 billion for debt repayments, $4.5 billion for the current account deficit, and $4.5 billion for reserve buildup. Roll-overs are expected to cover $8 billion, leaving a net financing requirement of $16 billion.
   • Achieving this level of financing is highly uncertain, given Pakistan’s low credit rating and the absence of any new borrowing from international commercial banks or the issuance of Euro/Sukuk bonds in FY24. Multilateral inflows have also declined by 30%, underscoring the need for an IMF program to provide a financial safety net.

3. Economic and Social Challenges

1. Investment and Employment:
   • Investment levels have plummeted to their lowest in 50 years, at 11.4% of GDP. Private investment, in particular, has shifted towards real estate, reducing the share of manufacturing and agriculture. This shift has implications for long-term growth and export diversification.
   • The unemployment rate has risen to 10%, with youth unemployment at 17.5%. The labor force has expanded, but job creation has lagged, leading to a significant increase in the number of unemployed individuals from 4.51 million to 6.26 million over three years.
2. Poverty and Living Standards:
   • Poverty has increased sharply, with an estimated 43% of the population, or over 104 million people, living below the poverty line. This rise is attributed to stagnant real incomes, high inflation, and limited social safety nets.
   • The Benazir Income Support Programme (BISP) has seen only a modest increase to Rs 590 billion, which is insufficient to address the growing poverty gap. A more substantial increase, equivalent to 25% of the poverty gap, is needed to provide meaningful support to the poorest households.

4. Risks and Policy Implications

1. Fiscal Sustainability and the IMF Program:
   • The FY25 budget relies heavily on optimistic revenue projections and the expectation of a large provincial cash surplus of Rs 1,217 billion. However, the combined surplus committed by provincial governments is under Rs 700 billion, indicating a potential shortfall of over Rs 500 billion.
   • Pakistan is expected to enter into a new three-year Extended Fund Facility with the IMF. Adherence to this program will require meeting stringent performance criteria and structural benchmarks, particularly in tax policy and SOE reform. Failure to meet these targets could result in frequent mini-budgets and create uncertainty in economic activities.
2. Inflation and Exchange Rate Risks:
   • The projected inflation rate of 12-12.7% for FY25 may be overly optimistic, given the potential for rupee devaluation and rising energy prices. Dr. Pasha predicts a more realistic inflation rate of 16-18%, reflecting persistent cost-push factors and high inflationary expectations.
   • Entry into the IMF program may necessitate a market-based exchange rate policy, leading to further devaluation of the rupee. This, combined with rising global crude oil prices and increased domestic energy tariffs, could exacerbate inflationary pressures.
3. Long-term Economic Stability:
   • Achieving sustainable economic growth and stability will require significant structural reforms, particularly in improving the business environment, enhancing export competitiveness, and diversifying the economy. The current focus on revenue mobilization through indirect taxes and SOE subsidies may not be sufficient to address the underlying weaknesses in the economy.

Comprehensive Table 

Conclusion

The FY25 budget and economic outlook for Pakistan are characterized by ambitious targets and significant risks. While the government aims to stabilize the economy through increased revenues and controlled spending, the underlying assumptions are highly optimistic. Achieving these targets will require effective implementation of policy measures, structural reforms, and continued support from international financial institutions like the IMF. Without these, the country may face further economic distress, social instability, and erosion of investor confidence. The need for a new fiscal pact with provincial governments and a comprehensive strategy to address the structural challenges in the economy is more critical than ever.