On Tuesday, Fitch Ratings characterised Pakistan’s budget for the fiscal year 2024-25 as “ambitious,” noting that it enhances the likelihood of securing a deal with the International Monetary Fund (IMF).
While Fitch acknowledged the uncertainty in meeting the fiscal targets, it highlighted that even partial implementation of the budget would likely narrow the fiscal deficit, thereby reducing external pressures, albeit at a potential cost to economic growth.
“The FY25 budget draft, released on June 13, is the first presented by Prime Minister Shehbaz Sharif’s coalition government. It projects a headline deficit of 5.9 per cent of GDP and a 2.0 per cent primary surplus, compared to the FY24 estimates of 7.4 per cent and 0.4 per cent respectively, through wide-ranging tax increases and significant fiscal efforts at the provincial level. The budget includes a notable increase in developmental spending and forecasts growth to accelerate to 3.6 per cent in FY25, up from 2.4 per cent in FY24,” Fitch stated in its commentary.
Pakistan’s Finance Minister Muhammad Aurangzeb unveiled the budget last week, targeting a modest 3.6 per cent growth for the upcoming fiscal year. The budget, with a total outlay of Rs18.9 trillion, represents a 30 per cent increase compared to the FY24 budget. Gross revenue receipts are expected to be Rs17.8 trillion, with the Federal Board of Revenue (FBR) taxes projected at Rs12.97 trillion, nearly 38 per cent higher than the previous fiscal year.
With this ambitious tax target, Islamabad aims to secure the IMF’s approval for a larger and longer-term bailout.
Fitch Ratings warned that these plans could face significant resistance within parliament from both coalition partners and opposition parties, as well as from broader society. This follows the close outcome of the February elections, which resulted in a weaker-than-expected mandate for the Pakistan Muslim League-Nawaz (PML-N).
“Our updated fiscal forecasts assume partial implementation and project a primary surplus of 0.8 per cent, factoring in shortfalls in revenue generation and an overshoot in current spending, partly offset by under-execution in development spending,” Fitch added.
“We believe tight policy settings may depress growth more than the government expects, reducing our growth forecast to 3.0 per cent for FY25, from 3.5 per cent, despite some improvements in short-term economic indicators. Nonetheless, the FY24 primary deficit is in line with the target, and the authorities have implemented unpopular subsidy reforms over the past year, supporting fiscal credibility.”
Fitch noted Pakistan’s historically poor track record in sustaining reforms, but acknowledged that the lack of viable alternatives has bolstered support for tough policy decisions in the near term.
Pakistan completed its nine-month IMF Stand-By Arrangement in April, and in May, the IMF reported “significant progress” towards agreeing on a new Extended Fund Facility (EFF).
“Government debt is expected to decline to 68 per cent of GDP by the end of FY24 due to high inflation and deflator effects, which offset soaring domestic interest costs. We anticipate inflation and interest costs to decline in tandem, with economic growth and primary surpluses gradually reducing the government debt-to-GDP ratio. The State Bank of Pakistan cut policy rates for the first time in five years on June 10 by 150 basis points to 20.5 per cent. We now forecast FY25 inflation at 12 per cent, and the end-of-year policy rate at 16 per cent,” Fitch detailed.
Despite stable debt dynamics, Fitch identified external liquidity and funding as Pakistan’s primary credit challenges.
“We believe a new IMF deal will be agreed upon, underpinning other external funding. However, maintaining the stringent policy settings necessary to keep external financing needs in check and comply with a new EFF could become increasingly challenging,” Fitch stated.
Pakistan’s external position has improved since February’s election, with the current account deficit on track to narrow to 0.3 per cent of GDP (just USD1 billion) in FY24, down from 1.0 per cent in FY23. This improvement is attributed to subdued domestic demand compressing imports, exchange rate reforms attracting remittance inflows back to the official banking system, and strong agricultural exports.
Gross reserves, including gold, now stand at USD15.1 billion, covering over two months of external payments, up from USD9.6 billion at the end of FY23.
“However, Pakistan’s projected funding needs still exceed reserves, at approximately USD20 billion per year in FY24–FY25, including maturing bilateral debt that we expect will continue to be rolled over. This leaves Pakistan vulnerable to external funding conditions and policy missteps,” Fitch concluded.
Pakistan’s ‘CCC’ rating, reaffirmed in December 2023, reflects the high external funding risks amid substantial medium-term financing requirements.
