Fitch Ratings says Pakistan’s ‘ambitious’ budget strengthens IMF deal prospects

Fitch Ratings on Tuesday called Pakistan’s budget for fiscal year 2024-25 “ambitious”, but stressed that it strengthens prospects for a deal with the International Monetary Fund (IMF).

“It is uncertain whether fiscal targets will be hit, but even assuming only partial implementation of the budget, we forecast the fiscal deficit will narrow. This should reduce external pressures, albeit at a cost to growth,” it said in the commentary.

Pakistan’s budget to support negotiations with IMF for new programme: Moody’s

“The FY25 (fiscal year ending 30 June 2025) budget draft, released on June 13, is the first presented by the coalition government of Prime Minster Shehbaz Sharif.

“It projects a headline deficit of 5.9% of GDP and a 2.0% primary surplus (FY24 estimate: 7.4% and 0.4%, respectively), on wide-ranging tax increases, and also significant fiscal efforts at the provincial level. The budget includes significantly more developmental spending, and sees growth accelerating to 3.6% in FY25 (FY24: 2.4%).”

Pakistan Finance Minister Muhammad Aurangzeb last week unveiled the budget targeting a modest 3.6% growth for the coming fiscal year, as Islamabad looked to appease the IMF and balance its burgeoning books with higher taxation.

The budget was announced with a total outlay of Rs18.9 trillion (up 30% compared to the budgeted outlay of FY24), and gross revenue receipts were expected at Rs17.8 trillion. The Federal Board of Revenue (FBR) taxes are envisaged at Rs12.97 trillion, an amount nearly 38% higher than the outgoing fiscal year.

We protected the salaried class, says finance minister Aurangzeb after budget speech

With an ambitious tax target, Islamabad is hoping that the IMF will give its green signal to Pakistan’s pursuit of a larger, longer bailout.

Fitch Ratings said these plans could face stiff resistance inside parliament – from both coalition partners and opposition parties – and among broader society, after the close outcome of the February elections delivered a weaker-than-expected mandate for Shehbaz Sharif’s Pakistan Muslim League-Nawaz (PML-N).

“Our updated fiscal forecasts assume partial implementation and project a primary surplus of 0.8%, on shortfalls in revenue generation and an overshoot in current spending, partly offset by under-execution in development spending,” Fitch Ratings added.

“We believe tight policy settings may depress growth more than the government expects, and have reduced our growth forecast to 3.0% for FY25, from 3.5%, despite some improvements in short-term indicators of economic activity.

“Nevertheless, the FY24 primary deficit is in line with the target, and the authorities have undertaken unpopular subsidy reforms over the past year, supporting fiscal credibility.”

Fitch said Pakistan has a poor record of sustaining reforms over time, but the absence of viable alternatives has strengthened support for tough policy decisions, at least in the near term.

Pakistan completed its nine-month IMF Stand-By Arrangement in April, and in May the IMF reported “significant progress” toward agreeing a new Extended Fund Facility (EFF).

“Government debt looks set to decline to 68% of GDP by FYE24 due to high inflation and deflator effects, offsetting soaring domestic interest costs. We expect inflation and interest costs to decline in tandem, with economic growth and primary surpluses driving government debt/GDP gradually lower. The State Bank of Pakistan cut policy rates for the first time in five years on 10 June, by 150bp to 20.5%, and we now forecast FY25 inflation at 12%, and the FYE25 policy rate at 16%.”

Fitch said external liquidity and funding are still Pakistan’s key credit challenges, despite stable debt dynamics.

“We believe a new IMF deal will be agreed, underpinning other external funding. However, sustaining the tight policy settings necessary to keep external financing needs in check, and to maintain compliance with a new EFF, could become increasingly challenging.

“Pakistan’s external position has continued to improve since February’s election. The current account deficit is on track to narrow to 0.3% of GDP (just USD1 billion) in FY24, from 1.0% in FY23. Subdued domestic demand has compressed imports, while exchange rate reforms have attracted remittance inflows back to the official banking system. Strong agricultural exports have also helped. Gross reserves (including gold) now stand at USD15.1 billion, over two months of external payments, up from USD9.6 billion at FYE23.

“However, Pakistan’s projected funding needs still exceed reserves, at about USD20 billion per year in FY24–FY25, including maturing bilateral debt that we expect will continue to be rolled over. This leaves Pakistan exposed to external funding conditions and policy missteps.

“Pakistan’s ’CCC’ rating, affirmed in December 2023, reflects high external funding risks amid high medium-term financing requirements.”