2 days ago
- Business
- Business Recorder
Outlook for public finances
The federal and provincial budgets for 2025-26 have generally been approved by the respective legislative fora. Therefore, it is possible to get an overall perspective of the likely outlook for public finances in 2025-26.
The targets on revenues, expenditures and surpluses/deficits by the federal and the four provincial governments tend to impart a high degree of optimism about the likely financial outcome in the coming financial year.
The consolidated budget deficit of the federal and provincial governments combined is targeted at Rs 6,501 billion in 2025-26. This will actually be lower even in absolute terms in relation to the deficit in 2024-25 of Rs 7,444 billion. The decline is even more pronounced as a percentage of the GDP, at 3.9 percent of the GDP as compared to 5.6 percent of the GDP in 2024-25.
Achieving a deficit of below 4 percent of the GDP will be an outstanding achievement. The last time we saw a deficit of below 4 percent of the GDP was as far back as 2003-04. In the intervening years, there have been years like 2018-19 when it approached even 8 percent of the GDP. For the first time the limit imposed by the Fiscal Responsibility and Debt Limitation Act of a maximum budget deficit target of up to 4 percent of the GDP is being adhered to.
The targeted budget deficit of 3.9 percent of the GDP is based on a federal deficit of 5.0 percent of the GDP and a provincial cash surplus of 1.1 percent of the GDP. The corresponding magnitudes for 2024-25 were respectively 6.5 percent of the GDP and 0.9 percent of the GDP. Therefore, bulk of the improvement in the state of public finances in 2025-26 is expected to come from a quantum reduction in the federal budget deficit by as much as 1.5 percent of the GDP.
These expectations are even more optimistic than the IMF. The Staff Report of the IMF of the 17th of May 2025, following the successful first review, envisages a consolidated budget deficit of 5.1 percent of the GDP in 2025-26 and a primary surplus of 1.6 percent of the GDP. The federal Ministry of Finance must be duly commended for aiming to even exceed the expectations of the IMF.
The fundamental problem is that the targeted deficit of 3.9 percent of the GDP and a primary surplus of 2.6 percent of the GDP in 2025-26 are based on fragile assumptions about the high growth in revenues and substantial containment of expenditures.
We focus first on the revenue projections and targets. The growth rate targeted for in FBR revenues is a strong 20.5 percent, compared to the projected increase in the GDP of 13 percent. The implied change in the federal tax-to-GDP ratio is 0.5 percent of the GDP. This is to follow the extraordinary jump in 2024-25 of 1.4 percent of the GDP. Consequently, inclusive of provincial tax revenues and the petroleum levy, which is effectively a tax, the national tax-to-GDP ratio is expected to rise to 13 percent of the GDP in 2025-26.
The realization of this target will imply that since 2022-23 there will be a spectacular improvement in the overall tax-to-GDP ratio by almost 3 percent of the GDP. In the event this happens, the performance in the realm of public finances, especially of the FBR, will need to be fully recognized.
However, the normal growth in FBR revenues is likely to be close to 12 percent, subject to the nominal GDP growth of 13 percent. Therefore, an additional increase of 10.5 percent is required through taxation measures in the federal budget. This is equivalent to Rs 1230 billion. The estimate of the likely generation of revenues from taxation measures and improvements in tax administration is close to Rs 650 billion. As such, there is a risk of a shortfall in FBR revenues of Rs 580 billion in 2025-26.
The other questionable projections relate to non-tax revenues. Despite the quantum decline in interest rates, SBP profits are expected to be very high at Rs 2400 billion, only marginally below the peak level of Rs 2,619 billion in 2024-25. The IMF Staff Report expects federal non-tax revenues in 2025-26 to be smaller by almost Rs 1000 billion in comparison to the level of these revenues in 2024-25. It is likely that the official estimates of non-tax revenues for 2025-26 are overstated by a similar amount.
The other source of non-tax revenue, which is probably also overstated, is the revenue from the petroleum levy. It is expected to rise by as much as 26 percent. A part of the increase will be due to the introduction of the carbon levy of Rs 2.50 per litre. However, with oil prices have gone up somewhat after the Iran-Israel war, there is less space for raising the petrol levy. This implies that there could be a shortfall of almost Rs 200 billion.
Overall, given the likely shortfalls identified above, the total federal revenues in 2025-26 may see a big shortfall of as much as Rs 1780 billion in relation to the targets. This will be equivalent to 1.5 percent of the GDP.
Turning to the expenditure side of the federal budget, there is need to start with some apparently good news. The level of current expenditure is targeted at Rs 16,286 billion in 2025-26, which is even lower in absolute terms than the level of Rs 16,390 billion in 2024-25.
The problem is that this absolute decline is expected to occur despite the 10 percent hike in salaries, 7 percent increase in pensions, 17 percent jump in defence expenditure and 20 percent expansion in the outlay on the Benazir Income Support Programme (BISP).
Where then are significant declines anticipated in other heads of current expenditure? The first is debt servicing. The mark-up payments are projected to decline by almost Rs 740 billion in 2025-26 from the actual level in 2024-25. This is despite the fact that the volume of government debt will increase by almost 8 percent. Clearly, the expectation is of a big fall in interest rates.
However, the rate of inflation, according to Consumer Price Index (CPI), is projected to rise to 7.5 percent in 2025-26 from 4.5 percent in 2024-25. Already, the core rate of inflation has approached 8 percent in May 2025. Further, the IMF will insist on a tight monetary policy in the Programme. Therefore, it is unlikely that there will be significant decline in interest rates in 2025-26 and the reduction proposed in debt servicing will be difficult to achieve.
The other current expenditure head where a containment is anticipated is in the subsidy bill. It is projected at Rs 1186 billion, compared to the actual level of Rs 1378 billion in 2024-25. Most of the fall is expected in the power tariff differential subsidy and other payments in the power sector of Rs 154 billion. Given the failure of the government to increase efficiency in operations of the power sector, this saving will remain very elusive.
Overall, the actual level of current expenditure in 2025-26 is likely to be higher due to the above-mentioned reasons by almost Rs 900 billion. This will be equivalent to 0.7 percent of the projected GDP in 2025-26. Overall, with revenues lower than the budgeted level by 1.5 percent of the GDP, the federal budget deficit is likely to be higher by 2.2 percent of the GDP, and approach 7.2 percent of the GDP.
Finally, there are clear indications from the provincial budgets that the provincial cash surplus of Rs 1464 billion for 2025-26 is unlikely to be met, especially with the likelihood of a significant shortfall in federal transfers. The only provincial government, which has targeted for a large cash surplus of Rs 963 billion, is that of Punjab. Sindh has actually shown a deficit. Therefore, a significant gap in achieving the target is likely of up to Rs 500 billion, equivalent to 0.4 percent of the GDP.
The bottom line is that the federal budget for 2025-26 is fragile. There are a number of factors identified, which could raise the consolidated budget deficit from the target level of 3.9 percent of the GDP to almost 6.5 percent of the GDP, even higher than the deficit of 5.6 percent of the GDP in 2024-25. The primary surplus is likely to be zero or even negative.
Given the relatively higher risk and uncertainty in the outlook for public finances in 2025-26, there is need for a high quality of financial management at the federal and provincial levels. We would like to see much less deviation than identified above from the key budgetary targets of 2025-26 and success in meeting the apparently less ambitious IMF programme targets.
Copyright Business Recorder, 2025
