Fiscal discipline achieved – can growth be next?

The last fiscal year’s bottom-line numbers are promising. The consolidated deficit was reduced to 2.6 percent of GDP, the lowest since FY04. It is a long way from FY22 and FY23, when the deficit averaged 7.9 percent of GDP and the country was on the verge of default. The government has posted a primary fiscal surplus for the third consecutive year, clocking 2.9 percent of GDP in FY26, perhaps the highest ever.

That has helped gross public debt come down from 75.2 percent of GDP in FY23 to 68.3 percent in FY26. Similarly, the debt servicing-to-net-fiscal-revenue burden has been slashed from 122 percent to 66 percent over the same period. That one element has provided enough space for some fiscal breathing room. However, this has not been achieved without a cost: the high tax burden, including the petroleum levy, and low development spending have choked economic growth.

In this budget (FY27), the government could have used that space to lower the tax burden. It did so marginally, but the load is still higher than it was in FY22. Much more is needed to change investors’ behaviour, as capital formation is disincentivized at such high tax rates.

The government, however, under pressure from the IMF to keep running primary fiscal surpluses, has set revenue, especially FBR tax, targets at unachievable levels. The tax strangulation continues.

In FY26, total consolidated fiscal revenues increased by 9.9 percent to Rs19.8 trillion, which is less than nominal GDP growth of 11.6 percent. Thus, there was a marginal decline in real terms. Federal tax revenues increased by 10.8 percent to Rs13.0 trillion, while provincial taxes performed better on a small base, rising by 23.5 percent to Rs1.2 trillion.

Non-tax revenues were up by a mere 5.3 percent to Rs5.6 trillion. The biggest increase within this was in petroleum levy (PL) collection, which rose by 28.5 percent to Rs1.6 trillion. Expect more growth this year, as the government is not reducing the rate despite skyrocketing petroleum prices in global markets. The biggest share of non-tax revenues comes from SBP profits, although these dipped by 7.3 percent to Rs2.4 trillion and are expected to fall further due to declining interest rates.

Overall consolidated fiscal expenditure was down by 4 percent to Rs23.1 trillion. The bigger decline was in federal expenditure, which was slashed by 10.3 percent to Rs15.3 trillion, thanks to a 22 percent decline in debt servicing costs due to falling interest rates.

Barring debt servicing, federal current expenditure was up by 10.5 percent. Within it, expenses related to the day-to-day running of the government and the military are growing in real terms. Defence expenditure is up by 18 percent, while spending on running the civil government is up by 16 percent. There is no austerity by the government that is reflected in the numbers.

The axe has fallen on subsidies, which are down by 22 percent, mainly due to lower power sector subsidies, as full cost recovery from consumers is in full swing. The other hit has been taken by federal PSDP spending, which was down by 12.5 percent. Consumers are paying through taxes and higher energy prices, while government-led jobs are falling due to cuts in development spending.

The federal fiscal deficit stood at Rs4.8 trillion, or 3.8 percent of GDP, down from 6.2 percent of GDP last year. The provinces then posted a surplus, bringing the overall consolidated deficit down to Rs3.3 trillion, or 2.6 percent of GDP.

The financing share of external sources grew this year, up by 90 percent to Rs1.2 trillion, while domestic financing was down by 62 percent to Rs2.1 trillion, as interest rates declined and some of the financing burden was taken up by external sources.

However, the domestic share of financing remained almost double that of external financing. Overall domestic debt is still growing, rising from 46.6 percent of GDP in FY22 to 46.9 percent in FY23, while external debt as a percentage of GDP fell from 25.1 percent to 19.1 percent over the same period.

The need is to build foreign financing, and that too on a long-term basis, to lower rollover risk. Create space for private credit in the domestic banking market and think about reducing taxes to enable private-led growth. The stage is set; it is time to focus on growth and employment generation.