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ISLAMABAD: Pakistan’s ambitious fiscal year 2025 budget strengthens prospects for an International Monetary Fund (IMF) deal, says Fitch Ratings.

The Ratings Agency also noted that Pakistan’s projected funding needs still exceed reserves, at about USD 20 billion per year in fiscal year 2024-2025, including maturing bilateral debt that we expect will continue to be rolled over. This leaves Pakistan exposed to external funding conditions and policy missteps. Pakistan’s ‘CCC’ rating, affirmed in December 2023, reflects high external funding risks amid high medium-term financing requirements.

The agency stated that it is uncertain whether fiscal targets will be hit, but even assuming only partial implementation of the budget, we forecast the fiscal deficit will narrow. This should reduce external pressures, albeit at a cost to growth.

The fiscal year 2025 (fiscal year ending 30th June 2025) budget draft is the first presented by the coalition government of Prime Minster Shehbaz Sharif. It projects a headline deficit of 5.9 percent of GDP and a 2 percent primary surplus (fiscal year 2024 estimate: 7.4 percent and 0.4 percent, respectively), on wide-ranging tax increases, and also significant fiscal efforts at the provincial level. The budget includes significantly more developmental spending, and sees growth accelerating to 3.6 percent in fiscal year 2025 (fiscal year 2024: 2.4 percent).

These plans could face stiff resistance inside parliament – from both coalition partners and opposition parties – and among broader society, after the close outcome of the February elections delivered a weaker-than-expected mandate for Sharif’s PML-N party.

“Our updated fiscal forecasts assume partial implementation and project a primary surplus of 0.8 percent on shortfalls in revenue generation and an overshoot in current spending, partly offset by under-execution in development spending. We believe tight policy settings may depress growth more than the government expects and have reduced our growth forecast to 3 percent for fiscal year 2025, from 3.5 percent, despite some improvements in short-term indicators of economic activity,” Fitch Ratings added.

Nevertheless, the fiscal year 2024 primary deficit is in line with the target, and the authorities have undertaken unpopular subsidy reforms over the past year, supporting fiscal credibility. While Pakistan has a poor record of sustaining reforms over time, the absence of viable alternatives has strengthened support for tough policy decisions, at least in the near term. Pakistan completed its nine-month IMF Stand-By Arrangement in April, and in May the IMF reported “significant progress” toward agreeing a new Extended Fund Facility (EFF).

Government debt looks set to decline to 68 percent of GDP by FYE24 due to high inflation and deflator effects, offsetting soaring domestic interest costs. We expect inflation and interest costs to decline in tandem, with economic growth and primary surpluses driving government debt/GDP gradually lower. The State Bank of Pakistan cut policy rates for the first time in five years on 10 June, by 150bp to 20.5%, and we now forecast fiscal year 2025 inflation at 12%, and the FYE25 policy rate at 16 percent.

External liquidity and funding are still Pakistan’s key credit challenges, despite stable debt dynamics. We believe a new IMF deal will be agreed, underpinning other external funding. However, sustaining the tight policy settings necessary to keep external financing needs in check, and to maintain compliance with a new EFF, could become increasingly challenging, the Ratings Agency added.

Pakistan’s external position has continued to improve since February’s election. The current account deficit is on track to narrow to 0.3% of GDP (just USD 1 billion) in FY24, from 1.0% in FY23. Subdued domestic demand has compressed imports, while exchange rate reforms have attracted remittance inflows back to the official banking system. Strong agricultural exports have also helped.

Copyright Business Recorder, 2024

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