An appraisal of FY25 federal budget

The Federal budget for 2024-25 has been presented in a mixed economic environment characterised by both positive and negative developments.

The GDP growth rate has turned positive to 2.4% from a negative 0.2% in 2023-24. The crop sector has recovered strongly from the 2022 floods and achieved an extremely high growth rate of 16.8%. However, the large-scale manufacturing sector is likely to show only zero growth.

The rate of inflation has steadily come down since December 2023. It is now down to only 11.8% in May 2024, partly due to the ‘high base effect’ of the peak rate of inflation in May 2023 of 38%. The Sensitive Price Index continues to show an inflation rate above 21%. The average rate of inflation in 2023-24 is likely to be close to 23%.

The revised estimates for 2023-24 indicate that the budget deficit is likely to be 7.4% of the GDP, with a primary surplus of 0.4% of the GDP. The target was 6.5% of the GDP. The revised estimate generally tends to understate the actual deficit. The likelihood is that the budget deficit in 2023-24 will approach 8% of the GDP and there will be a small primary deficit.

The very good news is the near zero current account deficit in the external balance of payments of 2023-24. During the first ten months, imports have contracted by 5%, while exports have increased by over 10%. Consequently, the foreign exchange reserves have remained stable at $9 billion.

The truly negative outcome is the fall in the level of fixed investment in Pakistan to its lowest level in the last 50 years. It is down to only 11.4% of the GDP, with decline both in private and public investment.

The living conditions of the people have been badly affected by the high cumulative inflation of 59% since 2021-22 and 69% in food prices. Simultaneously, there has been a drop in real per capita income of over 2%. The unemployment rate in the absence of high growth has risen to 10%, while the youth unemployment rate has jumped up to 17.5%. Meanwhile, the incidence of poverty has approached 43%. Today, over 103 million people are living below the poverty line in Pakistan.

Therefore, the Federal budget of 2024-25 needed to be framed in a way that some stimulus could be provided to economic growth and employment, while ensuring that the rate of inflation continues to remain low, and that priority is attached to providing relief to the poor.

Consequently, the budget ought to have focused on a significant cutback in current expenditure while raising revenues in a visibly progressive manner. This should have provided the fiscal space for raising development spending and fostering more employment, both directly and indirectly. Further, the focus ought to have been on larger pro-poor interventions.

Instead, the Government has not focused at all on economy in expenditure and proceeded only with an aggressive mobilization strategy, more from indirect taxes.

The PSDP is being doubled in size and with the big growth in revenues the expectation is that there will still be a quantum reduction in the budget deficit and a big jump in the primary surplus. There is only a modest increase in the size of the Benazir Income Support Programme.

We turn now to an in-depth examination of Federal revenues, expenditure and the financing of the fiscal deficit.

The targets in the Federal budget for revenues are very ambitious. FBR revenues are expected to increase by 40%, from Rs 9.3 trillion to almost Rs 13 trillion in 2024-25. The increase in direct tax revenues is anticipated to be 48% of the total increase in FBR revenues. Therefore, more than half of the increase is to come from indirect taxes. This implies more regressivity of the taxation proposals.

The estimated normal growth in FBR revenues in 2024-25 is estimated at close to Rs 1500 billion, in the absence of any taxation proposals. This implies that the revenue yield from the multitude of taxation measures will need to be over Rs 2,200 billion. This is equivalent to 1.8% of the projected GDP in 2024-25 and represents the highest ever target for additional taxation.

Successful performance by FBR in 2024-25 will take up the Federal tax-to-GDP ratio from 8.7% of the GDP in 2023-24 to 10.4% of the GDP in 2024-25. This increase of 1.7% of the GDP is more than the target indicated by the Finance Minister of an increase annually of 1% of the GDP.

The implied over-taxation will clearly adversely impact on the rate of GDP growth and the rate of inflation in 2024-25. Also, the overall incidence of the taxation proposals is likely to be regressive in nature and adversely affect more the lower income quintiles in the population. The inflationary impact will be compounded even more by the forthcoming big increases in energy tariffs.

The FBR has failed to give a detailed break-up of the additional revenue of Rs 2200 billion from the large number of taxation proposals in the budget. This increases the probability that the expected increase in revenue is significantly overstated.

Turning to Federal non-tax revenues, these are expected to jump up by as much as 64% in 2024-25, from Rs 2,947 billion to Rs 4,845 billion. This is to come from a colossal increase in the receipt of profits of the SBP from Rs 927 billion in 2023-24 to Rs 2,500 billion in 2024-25. Apparently, continuation of a high policy rate will contribute to the massive jump of 157% in SBP profits. However, the IMF projections of public finances in the Staff Report of May 10 do not show a similar quantum jump in non-tax revenues.

A preliminary analysis has been undertaken of measures to generate additional revenues. The first proposal of a controversial nature is the withdrawal of the benefit to exporters of 1% presumptive income tax and transition to a full income tax regime at 29% of net profits. Exports are the country’s lifeline today.

Bangladesh and India both offer big incentives to exporters. We have gradually withdrawn all the incentives at a time when fast growth in exports is required to reduce the country’s external vulnerability.

Already, the volume of exports of goods and services is expected to decline by almost 6% in 2023-24, according to the PBS. The future drop in net profitability could reduce further Pakistan’s export competitiveness and exacerbate Pakistan’s external vulnerability.

The other contentious move is the enhancement in the income tax on salary income. There is, no doubt, that the tax needs to be more progressive. However, this should have been accompanied by a rise in the exemption limit from Rs 600,000 to Rs 1,000,000, to protect relatively low salary earners.

A number of goods will be subject to a higher sales tax rate either by withdrawal of exemptions or enhancement of reduced rates. This includes medicines, medical equipment, poultry feed, tractors, cheaper mobile phones, stationery and newsprint. Further, the excise duty is being enhanced on cement and an additional customs duty is being imposed on many tariff lines.

There are some proposed measures which are welcome. This includes the withdrawal of the capital gains tax exemption beyond the holding period, higher advance tax on retailers and wholesalers, and the highest marginal tax rate of 45% on non-salary income. However, the Punjab and Sindh budgets continue the very favorable tax treatment of large agricultural incomes. This needs to be withdrawn if the income tax base is to be significantly broadened.

Turning to the expenditure side of the Federal budget, an increase of almost 21% is proposed in current expenditure, significantly above the likely rate of inflation. However, 51% of the rise is in debt servicing, with the likely continuation of a relatively high policy rate. The other source of increase is the 22% to 25% increase in salaries and 15% in pensions. Grants and subsidies are expected to increase by 20% and 27%, respectively. Overall, there is no evidence whatsoever of any economy in current expenditure.

A quantum jump is also proposed in the PSDP and lending by the Federal government in 2024-25. The PSDP is expected to virtually double in size. The sectoral priorities in the development programme are generally appropriate. An increase is proposed of 212% in the energy sector, 106% in water resources and 102% in physical planning and housing. However, the HEC gets an increase of only 10%.

The real disappointment in the Federal budget is the lack of adequate relief for the poor. As opposed to other big increases, there is only a moderate enhancement in the BISP to Rs 590 billion. This is at a time when the ‘poverty gap’ in the country has exceeded Rs 3000 billion. As a signal of equity, the BISP should have been increased by over 50%, such that its size would have exceeded Rs 750 billion, equivalent to 25% of the poverty gap.

The bottom line may perhaps appear to be somewhat surprising. Despite the quantum jumps in current expenditure of 21% and doubling of development spending, the budget deficit is to fall sharply in 2024-25.

The expectation is that it will decline from almost 8% of the GDP in 2023-24 to only 5.9% of the GDP in 2024-25. Simultaneously, the likely primary deficit in 2023-24 is to be greatly improved to a surplus of almost 2% of the GDP in 2024-25. However, all this will crucially depend on the achievement of the revenue targets.

There is also a fundamental change in the strategy for financing the Federal budget deficit. For the last few years non-bank borrowing has ceased to be a significant source of financing. The expectation now is that almost 34% of the deficit will be financed by inflows of savings into government schemes. This will be a positive development and reduce the inflationary impact of the deficit financing.

The other major area of concern is the expectation that the four Provincial governments combined will generate a cash surplus of Rs 1200 billion. This will reduce the consolidated budget deficit by 1% of the GDP. Historically, bulk of the cash surplus is generated by the two larger Provincial governments of Punjab and Sindh.

The Punjab government has targeted for a large cash surplus of Rs 650 billion, but the Sindh government has already indicated a zero surplus and instead increased phenomenally its development budget.

Therefore, the target of Rs 1200 billion will be difficult to meet and lead to a larger consolidated budget deficit. Clearly, the time has come for a new Fiscal Pact with the Provincial governments, as highlighted by the Finance Minister.

The budget has been designed to get the blessings of the IMF. This is likely given the targeted big increase in revenues and generation of a large primary surplus of 2% of the GDP.

However, it is a fragile budget with many risk factors, especially related to the almost 40% growth in FBR revenues, 64% growth in Federal non-tax revenues and the generation of a Provincial cash surplus of 1% of the GDP. As there may be significant shortfalls, we are likely to see a spate of mini budgets in 2024-25, to keep operational the IMF program.

Copyright Business Recorder, 2024