Fiscal gains with pain

The fiscal consolidation continues. In 1HFY25, the government posted the lowest fiscal deficit as a percentage of GDP since 1HFY06—nearly twenty years. However, this outcome was achieved due to abnormally high SBP profits of Rs2.5 trillion in 1QFY25, reported for the full year FY24. The deficit is expected to normalize in the second half, likely reaching around 5.7–5.9 percent of GDP, the lowest since FY17 or FY18. The unwinding of higher debt accumulated over recent years has begun, but the process is painstaking and far from complete.

The total budget deficit stood at Rs3.43 trillion during 2QFY25, while the primary deficit was reduced to Rs1.54 trillion in 1HFY25, supported by a surplus in 1QFY25 due to higher SBP profits. The budget deficit, as a percentage of GDP, fell to 1.2 percent in 1HFY25 compared to 2.3 percent in the same period last year.

In addition to SBP profits, significant revenue growth came from FBR taxes, which increased by 26 percent to Rs5.63 trillion, surpassing 5 percent of GDP—one of the highest tax collections for the first half ever. FBR revenues are projected to reach Rs12 trillion for the full year. While this would fall short of the ambitious target, it would still represent the highest tax-to-GDP ratio (10.5%), owing to a lower-than-expected nominal GDP caused by declining inflation and slower real growth.

However, the stalling growth in tax revenues is concerning. The disproportionately high tax burden on the formal sector has strangled growth, while efforts to broaden the tax base and bring untaxed sectors into the net remain lacking. The formal sector’s ability to bear higher taxes is diminishing.

Within taxes, the balance is shifting towards direct taxes, with their share rising from an average of 38 percent during FY15–22 to 47 percent in FY23–24, driven by the imposition of super tax and higher income taxes on interest earnings. Indirect tax growth has slowed due to weak economic activity and falling imports. Some rebalancing is expected in FY25 as imports and industrial growth pick up, benefiting indirect tax collections.

In 1HFY25, direct taxes increased by 29 percent to Rs2.78 trillion, while indirect taxes rose by 25 percent to Rs2.84 trillion. Sales tax collections climbed by 25 percent to Rs1.90 trillion.

On the expenditure side, total spending increased by 22 percent YoY to Rs8.20 trillion. Quarterly spending surged by 130 percent from 1QFY25 to Rs4.27 trillion in 2QFY25, mainly due to higher debt servicing costs. In 2QFY25, debt servicing rose almost threefold from 1QFY25 to Rs3.84 trillion, driven by the maturity of T-Bills borrowed at peak rates. Overall, debt servicing increased by 22 percent YoY to Rs5.14 trillion in 1HFY25. This is expected to decline in 2HFY25 as the impact of lower interest rates starts to materialize.

The fiscal space created may be allocated to higher subsidies and development spending. Subsidies decreased by 37 percent in 1HFY25 to Rs237 billion, while development spending increased by 8 percent to Rs165 billion. Defense expenditure grew by 18 percent to Rs890 billion during the same period.

The federal budget deficit fell by 14 percent to Rs2.3 trillion, supported by a provincial surplus of Rs775 billion (up 168 percent YoY from Rs289 billion in 1HFY24). The primary surplus nearly doubled YoY to Rs3.60 trillion in 1HFY25, comfortably meeting the IMF target of Rs2.88 trillion and staying on track to achieve the full-year surplus target of Rs2.44 trillion.