Pakistan: Budget for FY23 – Govt tightens fiscal policy to revive IMF loan programme

• The government sets an ambitious GDP growth target of 5% y/y in FY23; inflation projected to remain in double digits
• Tax revenue to rise by 16.7% y/y, about PKR 355bn of additional taxes imposed
• Petroleum development levy to be reimposed, leading to a sharp rise in pump prices in coming months
• Total expenditure to rise just 4.8% y/y, reflecting prudent spending by the government
• Petroleum and power subsidies have been slashed significantly
• Fiscal deficit pegged at 4.9% of GDP in FY23, down markedly from an estimated 7.1% in FY22
• The government is aiming to raise PKR 372bn (about USD 1.9bn) via Eurobonds/Sukuk
• Taxes on real estate and banking sectors increased while salaried class and farmers were facilitated

The newly elected coalition government on Friday unveiled the federal budget for FY23 (begins July 1, 2022) amid ongoing negotiations with the IMF for the resumption of the USD 6bn Extended Fund Facility. With uncertainty around Pakistan's ability to secure external financing, the budget was designed to meet the IMF conditions, which would give the government access to the remaining USD 3bn loans under the EFF besides helping it unlock funds from other multilateral, bilateral and commercial sources. "There will be some pain," FinMin Miftah Ismail said at a post-budget press conference as he pointed out that fiscal consolidation is the government's priority to avoid a Sri Lanka-like crisis.

Given that most of the IMF's demands have been acceded to, it appears that the government will be able to take the country out of external liquidity crisis. However, the short-term stability will come at the cost of reduced purchasing power of households as the budget is highly inflationary.

Macroeconomic framework

The government has set a GDP?growth target?of 5% y/y in FY23, down from an estimated 6.0% y/y in FY22. In his budget speech, FinMin Miftah Ismail said that the government had to move towards "sustainable growth", adding that the biggest challenge for the government would be to achieve the targeted growth while preserving the country's external sector stability. We note that the relatively strong economic growth in this fiscal year led to the ballooning of the current account deficit, which along with foreign debt repayments has posed a serious threat to the country's external sector. With the IMF's Extended Fund Facility in suspension following the announcement of fuel and electricity subsidies by the previous government on Feb. 28, Pakistan has been facing an imminent balance of payments crisis. The crisis, however, is unlikely to materialize as the IMF's loan programme is expected to be revived after the government met most of the Fund's demands, including reversal of energy subsidies and pursuing a path of fiscal consolidation. The general government fiscal deficit has been projected to fall to 2.8% of GDP by FY25 from an estimated 7.1% in FY22.

The government's GDP forecast for FY23 is quite optimistic than the projections of the World Bank (4% y/y), IMF (4.2% y/y), Asian Development Bank (4.5% y/y), Moody's (4.2% y/y) and S&P (4.3% y/y). Moreover, the State Bank of Pakistan (SBP) also expects the country's economic growth to ease to 3.5-4.5% y/y in the next fiscal year on the back of monetary tightening and IMF-backed fiscal consolidation. Going forward, the government sees GDP growth to accelerate to 5.8% y/y in FY24 and 6.2% y/y in FY25. A prolonged conflict between Russia and Ukraine, tightening of global financial conditions, domestic political uncertainty and exchange rate depreciation were identified as major risks to Pakistan's economic outlook.

On the price front, the government projected the average CPI inflation to remain elevated at 11.5% y/y in FY23, which will moderate to 8.6% y/y and 7.4% y/y in FY24 and FY25, respectively. This means that inflation would decelerate towards the target of 5-7% y/y over the medium-term on account of fiscal consolidation, normalization of global commodity prices and beneficial base effects.

Federal Government Budget

Revenue Receipts

The total revenue budgeted for FY23 stands at PKR 9.0tn, which is PKR 1.7tn (23.1% y/y) higher than the revised estimates (RE) of FY22. The bulk of this increase would come on the back of tax revenue, which is collected by the Federal Board of Revenue (FBR). The government seeks to raise PKR 7tn in tax revenue in FY23 against PKR 6.0tn collected in this fiscal year. According to budget documents, about PKR 355bn of the PKR 1tn increase in tax revenue would be generated through additional taxation measures and enforcement measures while the rest would accrue on account of inflation and GDP growth.

Likewise, non-tax revenue has been pegged at PKR 2.0tn in FY23, some 52.7% y/y higher than the RE of FY22. Nearly two-fifth of the non-tax revenue or PKR 750bn will be collected from petroleum development levy (PDL), up 455.6% y/y, suggesting pump prices would surge further given the withdrawal of fuel subsidy - a requirement to revive the IMF programme - and elevated global crude oil prices. Moreover, the Gas Infrastructure Development Cess - a tax collected from the industrial sector for the development of gas infrastructure in the country - would be reinstated, with the government expecting to raise PKR 200bn from this head in this fiscal year. Surplus profit of the State Bank of Pakistan (SBP) is estimated to fall by 36.7% y/y to PKR 300bn. This is largely because lending to the government - a major source of income of the central bank - has been?prohibited?by the IMF under its reforms programme.

Meanwhile, the federal government will transfer funds worth PKR 4.1tn (up 16.7% y/y) to the four provinces from the divisible pool taxes in FY23. More than half of the funds will be received by Punjab - Pakistan's most populated province - while the rest will be distributed among the other three provinces - Sindh, Khyber Pakhtunkhwa, and Balochistan. Subsequently, the federal government's net revenue is projected to be PKR 4.9tn in the next fiscal year.

Expenditure

The size of the federal budget is estimated at PKR 9.5tn in FY23, up slightly by 4.8% y/y, indicating that the government adopted fiscal prudence to comply with the IMF recommendations. This comes as the current expenditure has been budgeted to rise by just 2.1% y/y to PKR 8.7tn, primarily owing to the sharp cut in subsidies. For instance, power sector subsidy will be reduced by 46.8% y/y to PKR 570bn, which would?jack up national average electricity tariffs?by over 20%, analysts said. Similarly, some PKR 71bn would be given in petroleum subsidy, down from PKR 377bn in FY22.

More than three-fifth of the current expenditure will go towards debt servicing and defence services. The government will spend nearly PKR 4.0tn on interest payments in this fiscal year, an increase of 25.7% y/y whereas defence expenditure has been budgeted at PKR 1.5tn, up 2.9% y/y, which is along expected lines considering the internal and (perceived) external threats facing the country.

It is noteworthy that the allocation for defence services does not give a full picture of the actual amount the government would be spending on the armed forces. For instance, of PKR 530bn funds earmarked for pension, PKR 395bn would be paid to the retired military personnel, which would come from the civilian government's current expenditure instead of the defence budget. Further, there is also lack of transparency around the expenses incurred on import of military hardware and running of the nuclear programme.

Function-wise breakdown of the current expenditure shows that the government has budgeted PKR 19.6bn for the health sector in FY23, which is a massive reduction from PKR 154bn spent in this fiscal year. This may be mainly due to the absence of COVID-19 vaccines procurement. Spending on the education sector will see a marginal increase of 4% y/y to PKR 90.6bn in FY23, with more than four-fifth of the budgeted amount allocated for tertiary education. The government will also provide PKR 1.2tn in grants to provinces, ministries and departments. Of this, PKR 360bn has been budgeted for benazir income support programme while PKR 363bn will be given as sovereign guarantees on behalf of the public sector enterprises.

Meanwhile, federal development expenditure has been pegged at PKR 727bn in FY23, up markedly from PKR 550bn spent in this fiscal year. It is noteworthy that in the previous year's budget, the government set a PKR 900bn target for development expenditure, but it had to significantly reduce its spending on the directions of the IMF in a bid to rein in the fiscal deficit. Analysis of the previous budgets show that actual development spending has almost always fell short of budgeted amount, therefore, it will be seen how much of the PKR 727bn development expenditure the government will be able to spend in FY23 considering it is under an IMF program that imposes fiscal constraints.

Budget deficit/financing

The federal government fiscal deficit has been projected at PKR 4.6tn in FY23. However, about PKR 800bn would be retained by the Centre as provincial cash surplus, which would bring down general government fiscal deficit to PKR 3.8tn. The deficit equals 4.9% of GDP in FY23 against an estimated 7.1% in FY22 (which was originally budgeted at 6.3%). Moreover, in an effort to meet a key objective required under the IMF's loan programme, the government has provided for a primary budget surplus of PKR 152bn in FY23 compared to a deficit of PKR 360bn during the current fiscal year.

The federal government fiscal deficit would be financed through net PKR 4.0tn domestic loans, net PKR 533.1bn external loans while PKR 96.4bn is also targeted to be generated from privatization of state-owned assets. The government seeks to raise PKR 372bn (about USD 1.9bn) via Eurobonds/Sukuk and PKR 1.4tn (about 7bn) from foreign commercial banks in FY23.

Fiscal policy changes/salient features of FY23 budget

Taxes on real estate

The government imposed several taxes on real estate sector to disincentivize investment in "non-productive assets". Firstly, all immovable properties (other than a house for own residence) with a fair market value of more than PKR 25mn will be taxed at 20% of the deemed rental income, which will be equal to 5% of the property's fair market value. Secondly, a 15% capital gains tax will be levied on immovable properties if the holding period is less than a year. The tax would be reduced by 2.5% every subsequent year, eventually going down to zero once the holding period reaches six years. Lastly, the advance tax rate on purchasing property for tax filers has been raised to 2% from the current 1%.

Incentivizing savings

The government reduced the tax rate on profit from investment in saving certificates to a maximum of 5% instead of 10% at present.

Penalizing non-tax filers

Taxes on individuals who do not file a tax return have been increased to widen the tax base. For instance, they will now have to pay 200% advance tax on vehicles with engine capacity of over 1600cc, up from 100%. Advance tax rate on buying and selling property for non-filers has also been raised to 5%.

Push towards green energy

Sales tax on imports and local supply of solar panels have been abolished (from 17% currently) to encourage the production of renewable energy in the country. The government will provide soft loans to households that consume less than 200 units of electricity to purchase solar panels, FinMin Ismail said. Moreover, import duties on hybrid cars have also been decreased by up to 100%.

Taxing the rich

Individuals or companies with annual income above PKR 300mn will have to pay an additional 2% tax. Further, payments made through credit/debit cards to a foreign country would be charged with 1% advance withholding tax. Capital gains tax has been imposed when selling of cars worth over PKR 5mn.

Facilitating the salaried class

The federal government increased the salaries of its employees by 15%. Besides, the minimum salary eligible for income tax has been increased to PKR 1.2mn as compared to PKR 0.6mn to facilitate the salaried class.

Increasing farmers' productivity

Sales tax on tractors and seeds have been eliminated from the current 5% and 17%, respectively. Custom duty on agriculture machinery has also been abolished.

Banking sector

The windfall gain tax on banking companies has been increased by 3pps to 42%.

Promoting film industry

The government offers a five-year tax holiday to film-makers, besides tax rebate for five years to new cinemas, production houses and film museums and 10 years for film and drama export, exemption on cinemas and producers' income, withholding tax to film producers and distributors and zero sales tax and customs duty on import of film equipment.