Problems with IMF projections—II

The previous article had highlighted the problems with the macroeconomic projections by the IMF in the Staff Report of September 2024 on the new Extended Fund Facility for Pakistan for 37 months.

The focus of this article is on the IMF projections of the general government budget from 2024-25 to 2026-27.

There is initially a need to emphasize that these public finance projections are truly ambitious and challenging for the federal and provincial governments in Pakistan.

Problem with IMF projections

Achievement of these targets will greatly stabilize the economy and facilitate faster growth with lower inflation. These projections/targets have been finalized with concurrence from the Pakistani side in the loan negotiations.

The ambitious nature of these projections can be judged by the sharp decline expected in the budget deficit. It was 6.8 percent of the GDP in 2023-24, which already represented significant improvement from the deficit of 7.8 percent of the GDP in 2022-23.

The expectation is that the year, 2024-25, will close with a deficit of 6.1 percent of GDP in 2024-25. This is projected to fall to 6.0 percent of the GDP in 2025-26 and to only 4.7 percent of the GDP in 2026-27. The last time Pakistan had a fiscal deficit of below 5 percent of the GDP was as far back as 2004-05. Simultaneously, the expectation is that the primary balance will be 2 percent of the GDP in 2024-25 and remain at, more or less, this level in 2025-26 and 2026-27.

The fundamental question is how this substantial improvement in the fiscal position is to be achieved? Total tax revenues are expected to show a spectacular jump from 10.5 percent of the GDP in 2023-24 to 13.4 percent of the GDP by 2026-27. The major part of this increase is expected to come in 2024-25.

However, a rise in the tax-to-GDP ratio of 1.8 percent of the GDP in 2024-25 has to be seen in relation to the nominal GDP growth. This is expected to be only 14.7 percent. However, the growth rate of tax revenues has been projected at 34 percent by the IMF. In other words, taxation reforms are anticipated to yield as much as Rs 1297 billion in 2024-25. This is well beyond the realm of possibilities. Already, we are seeing a growing shortfall in FBR revenues in the first four months of 2024-25.

There is a more modest expectation on the expenditure side. Total public expenditure is expected to remain at close to 19 percent of the GDP. However, major changes are anticipated in the composition of expenditure. Debt servicing is expected to fall from 7.7 percent of the GDP in 2023-24 to 5.6 percent of the GDP in 2026-27.

This will enable an increase in provincial current expenditure by almost 1 percent of the GDP, hopefully mostly on education and health. Also, a growth impetus will be provided by a jump in development spending from 1.9 percent of the GDP in 2023-24 to 2.6 percent of the GDP by 2026-27.

Beyond this exotic set of targets, there are some specific problems with the IMF projections of public finances.

The first problem is with the targets of individual FBR revenues in 2024-25. The Ministry of Finance made large errors in the revised estimate of these revenues in 2023-24. Consequently, the target growth rate in income tax has been shown at 26 percent only as compared to over 50 percent in indirect taxes. Clearly, these revenue targets for 2024-25 have to be changed.

The estimate in the IMF Staff report which is significantly understated is the level of security spending. It is estimated at Rs 2,122 billion in 2024-25. This is understated because it does not include the expenditure on military pensions and on civil armed forces. The result is that the projected level of security spending is likely to be 44.6 percent higher at Rs 3069 billion.

The next issue is with regard to the provincial cash surplus in 2024-25. The resort to the IMF projections and transfers to provincial governments in the budget documents implies a provincial cash surplus of almost Rs 1250 billion in 2024-25.

There is a need to recognise that the four provincial governments in their respective budgets for 2024-25 have collectively targeted for a much lower combined magnitude of cash surplus of Rs 755 billion. It is expected by the Punjab government to be Rs 630 billion, while the three other Provincial governments are targeting for a small combined surplus of Rs 125 billion. In particular, Sindh aims to have a balance budget with zero surplus.

The other surprise in the IMF Staff public finance projections is that in 2024-25, there will be no privatisation receipts. The federal Ministry of Finance has targeted for a modest Rs 30 billion in these receipts. However, among the structural conditionalities in the IMF programme, there is the expectation that two DISCOs will be prepared for privatization by end-January 2025. Also, the process of privatization of PIA is under way.

Finally, there is a matter of some concern. According to the indicative target of FBR revenues in the Programme, there is to be an acceleration in the quarterly growth rate in 2024-25 as follows:

First Quarter 29.9 percent

Second Quarter 38.3 percent

Third Quarter 40.9 percent

Fourth Quarter 44.1 percent

However, there is no such underlying historical seasonality in the quarterly growth rates. Is the IMF expecting that there will be a mini-budget at the end of each quarter to accelerate the growth rate of revenues in the subsequent quarter?

Overall, the projections of the general government budget over the tenure of the IMF Programme in the IMF Staff Report are extremely ambitious and bordering on being unrealistic. They represent an unprecedented challenge for the federal and the provincial governments. The greater likelihood of failure to achieve the targets committed to could jeopardize the uninterrupted continuation of the Programme and create greater uncertainty about the flow of funds into Pakistan.

Copyright Business Recorder, 2024