The provincial budgets of FY26

Business Recorder

5 days ago

The four provincial budgets were announced last week. The first budget presented was that of Sindh, followed by Punjab, Khyber-Pakhtunkhwa and Baluchistan.
The provincial budgets for 2025-26 are expected to be in line with the projections agreed with the IMF as revealed in the IMF Staff Report of 17th of May. This report was released following the successful completion of the first review of the three-year Extended Fund Facility.
There has been a visible shift of focus towards the fiscal performance of provincial governments in the IMF Programme. Performance criteria and indicative targets include the public expenditures on health and education, which are mostly by the provincial governments. In addition, the four provincial governments combined are expected to achieve a target level of tax revenues and a pre-specified level of provincial cash surplus. This is to bring down the consolidated budget deficit and facilitate the achievement of a target level of primary surplus.
The IMF Staff Report indicates the following expectations regarding provincial budgets in 2025-26:
(i) Growth rate in provincial own-tax revenues of over 27 percent. This is linked to the effective implementation and significant generation of revenues from the new Agricultural Income Tax Act, legislated by each Provincial government in the beginning of 2025.
(ii) Moderate growth in current expenditure of under 15 percent, to provide fiscal space for enhanced allocations to education and health.
(iii) Modest growth rate of 12 percent in development expenditure from the likely level of Rs 1870 billion in 2024-25 to Rs 2100 billion in 2025-26.
(iv) Generation of a sizeable combined provincial cash surplus of Rs 1500 billion, implying a big jump of 50 percent over the likely level of Rs 1000 billion in 2024-25.
The above expectations are based on a rapid growth in federal transfers to the four provincial governments combined of 22 percent.
The fundamental question is whether the four provincial budgets are consistent with the realisation of the above targets.
The first critical magnitude is that of the projected size of federal transfers to the provinces. The federal budget document, Budget in Brief of 2025-26, reveals that the total transfers consisting of NFC Divisible Pool transfers, straight transfers and grants will aggregate to Rs 8206 billion, with the growth rate of 17.3 percent. This is somewhat lower than the expectation of 22 percent growth.
The next critical target in the IMF Programme is extraordinary growth in provincial own-tax revenues, facilitated by substantial higher collections from the agricultural income tax.
The truly surprising discovery from the four provincial budget documents is that the overall national collection from the agricultural income tax will be only Rs 19 billion. Surely, with the same income tax rate as for non-agricultural incomes and with agricultural incomes approaching 22 percent of the economy, the revenue estimate should have been in hundreds of billions. A feasible target of Rs 150 billion could have been set for the first year in 2025-26, with due allowance for the low outputs from wheat and cotton. Clearly, the powerful lobby of the very large farmers has prevailed once again.
There is substantial variation in the budgeted growth of current expenditure in 2025-26 by the four provincial governments. The highest growth rate that has been set is by the government of Sindh at 25.3 percent and the lowest at 0.9 percent by the government of Punjab. Combined the growth rate of current expenditure is 14.8 percent, which is in line with the IMF expectations.
However, the four provincial governments have set very ambitious growth rates for development spending. It ranges from a maximum of 43.6 percent in the case of Baluchistan to a low of 11.9 percent in Punjab. Combined, the proposed level of development expenditure is Rs 3105 billion. This is substantial larger than the level indicated for 2025-26 in the IMF Staff Report of Rs 2099 billion. Clearly, the provincial governments are proposing to promote growth through investment in infrastructure and services.
We come now to effectively the bottom line, corresponding to the targeted magnitude of the cash surplus by each provincial government. There is substantial variation here also. The government of Punjab hopes to generate a large cash surplus of Rs 943 billion, which is 41 percent higher than the likely level this year. This will be equivalent to 63 percent the combined national targeted cash surplus of Rs 1500 billion indicated by the IMF.
The big surprise is that the government of Sindh expects the provincial budget to actually be in deficit of Rs 38 billion. This is very unusual since limits have been placed on borrowings by provincial governments. The Khyber-Pakhtunkhwa and Baluchistan governments have shown small surpluses of Rs 126 billion and Rs 51 billion, respectively.
Overall, given the provincial budgets, the combined provincial cash surplus is targeted at Rs 1082 billion, significantly below the amount revealed in the federal budget of Rs 1500 billion, and Rs 1500 billion also in the IMF Staff Report. Consequently, this will increase the consolidated budget deficit by 0.4 percent of the GDP and reduce the primary surplus from 2 percent to 1.6 percent of the GDP.
Overall, the provincial budgets have generally been disappointing. The agricultural income tax is not being effectively implemented. Other taxes like the urban immoveable property tax and the sales tax on services continue to remain underdeveloped. There is under-budgeting of the cost of increasing salaries and pensions, which will further reduce the provincial cash surplus.
The time has come for much greater focus on the finances of provincial governments. They now account for 30 percent of national public expenditure but finance only 17 percent of this expenditure. The first time focus in the IMF on key provincial budget magnitudes needs to be sustained and strengthened whenever necessary, especially on mobilization of substantially larger revenues.
Copyright Business Recorder, 2025