All in the name of the IMF

There is a consistent element of ad hoc-ism in national economic policies

All in the name of the IMF


inance Minister Muhammad Aurangzeb has presented the federal budget 2024-25 with a total outlay of Rs 18.9 trillion (up 30 percent compared to the budgeted outlay of FY24) with a strong focus on increasing taxes and levies. The budget sets an ambitious Rs 13 trillion tax revenue target, raising taxes on the salaried classes and removing various tax exemptions. Additionally, the petroleum levy has been significantly increased, reflecting the government’s efforts to boost revenue and address economic challenges.

The federal budget for 2024-25 closely follows International Monetary Fund guidelines to secure a fresh $6-8 billion bailout. It sets ambitious fiscal targets, including a 40 percent increase in tax revenue to Rs 13 trillion. This includes a 48 percent raise in direct taxes and a 35 percent increase in indirect taxes, such as 18 percent sales tax on textiles, leather products and mobile phones; and higher capital gains tax on real estate. These measures aim to boost revenue, reduce the fiscal deficit from 7.4 percent to 5.9 percent of the GDP and improve the balance of payments.

The IMF guidance is crucial due to Pakistan’s economic instability, characterised by slow growth, high inflation and significant fiscal and external deficits. The need for a new IMF loan stems from the urgency to avoid default, as shown by the previous (short-term) bailout ($3 billion). In raising taxes and removing exemptions, the government aims to meet IMF demands despite significant political challenges.

The budget has drawn both praise and criticism. On the positive side, the abolition of several tax exemptions and the inclusion of the real estate sector into the tax regime are unexpected welcome steps towards better documentation and taxation of traditionally untaxed sectors.

The budget also indicates a shift towards a market-based economy, reducing protectionism and subsidies while emphasising efficiency through electronic systems. Additionally, incremental positive steps, such as maintaining the Capital Gains Tax rates for filers and increasing the Benazir Income Support Programme allocation by 27 percent, reflect a commitment to digitisation, automation and building climate resilience.

The budget has been criticised for missing opportunities for bold reforms and continuing to overburden existing taxpayers rather than broadening the tax base. The increased taxes, particularly the higher petroleum development levy and sales tax, are expected to exacerbate inflationary pressures and economic challenges.

The ambitious 40 percent increase in tax revenue has been met with skepticism. There are concerns that this may lead to shortfalls and require additional mid-year measures. The lack of substantial structural reforms in the tax, governance and export sectors, along with the negative impact on exporters due to their inclusion in the tax regime, highlights the significant challenges in achieving sustainable growth and macroeconomic stability.

While the budget caters to the IMF sensibilities, aiming to secure a $6 billion to $8 billion programme through substantial fiscal adjustments, there is a consistent element of ad hoc-ism in national economic policies.

This ad hoc-ism stems from deep-rooted political fault lines, persistent instability and ongoing uncertainty that make it challenging to implement necessary structural adjustments. These adjustments, essential for long-term economic stability and growth, carry a high political cost that governments have often been unwilling to bear.

Consequently, despite the budget’s alignment with IMF demands through measures such as increasing taxes and removing exemptions, the underlying political dynamics hinder the establishment of a coherent and sustainable economic policy framework. The political environment prioritises short-term gains and crisis management over comprehensive reform, perpetuating a cycle of economic vulnerability and reliance on external assistance.

A crucial structural adjustment Pakistan urgently needs is addressing its severe debt problem, which has become a significant burden on national resources. The country’s debt-to-GDP ratio exceeds 70 percent. The interest payments consume between 50 percent and 60 percent of government revenues, one of the highest ratios globally.

The situation is exacerbated by low foreign exchange reserves, barely covering a few weeks of essential imports and imminent bond payments. Despite these critical challenges, the current budget offers little by way of reducing this heavy debt burden.

Addressing this issue is difficult given the political uncertainties in Pakistan. The strong opposition and the vulnerabilities of the coalition government, resulting from a split mandate in the last general elections, hinder the implementation of necessary but politically costly structural adjustments.

Use of external debt for consumption, instead of productive investment; poor export performance; and reliance on quick-disbursing loans have worsened the debt crisis. The budget’s focus on immediate fiscal targets defers comprehensive reforms needed for long-term debt sustainability, highlighting a significant gap in addressing the country’s economic stability.

The penchant for quick fixes manifests in several ways. While sustained economic growth requires increased productivity, innovation, robust infrastructure, effective governance, comprehensive education reforms and a favourable business environment—as exemplified by the development trajectories of the Asian tigers—Pakistan has pinned its hopes on foreign investment, including Arab investment and Chinese investment under the CPEC.

One consequence of this approach is that Pakistan has rarely distinguished itself in terms of productivity increases, especially in emerging sectors like information technology. For several decades, the average yields in the agricultural sector have fluctuated around stationary trends. This correlates with declining educational standards, despite more parents investing heavily in their children’s education.

When the productive capacity of an economy does not significantly increase, imposing more taxes merely creates distortions and undermines the incentive system. The finance minister is right in advocating for broadening the tax net, but bringing millions living below the poverty line into tax net is futile.

With Pakistan’s large and rapidly growing population, projected to become the third largest after India and China, failing to enhance the country’s productive capacity is perilous. A massive young population lacking adequate marketable skills to contribute to the national economy or work overseas spells inevitable disaster.

More taxes will primarily serve to pay the ever-increasing interest, perpetuating a cycle of debt without fostering sustainable growth. This approach risks plunging the country deeper into economic turmoil, as essential structural reforms and investments in productivity and education are missing.

The writer is a tenured associate professor and head of the Department of Economics, COMSATS University Islamabad, Lahore Campus

All in the name of the IMF