FY2025-26: Budget estimates

The federal and provincial budgets for 2025-26 are likely to be announced in early June. Already, the first review report by the IMF Staff, which was released on the 17th of May, contains detailed estimates of both; the likely fiscal outcome in 2024-25 and budget estimates for 2025-26.

The objective of this article is to identify, first; the deviations in the projected outcome in 2024-25 from the original budget estimates and second, to examine the magnitude of the key fiscal indicators for 2025-26.

The budgetary outcome, according to the IMF Staff Report, is likely to be significantly better than originally envisaged. The budget deficit is estimated at Rs 6,486 billion, as compared to the initially targeted level of Rs 7,344 billion. This is perhaps the first time in many years we are likely to see this type of positive outcome. The budget deficit in 2024-25 is estimated at 5.6 percent of the GDP, as compared to the initial budget estimates of 6 percent of the GDP.

How has this favorable outcome been achieved? It is primarily due to a significant containment of expenditure by Rs 1132 billion and a quantum jump in non-tax revenues of Rs 1614 billion. The steep reduction in interest rates in 2024-25 is likely to lead to a saving in the cost of debt servicing by as much as Rs 914 billion.

The position on the revenue side is a projected shortfall in 2024-25 of only Rs 274 billion, despite a shortfall in FBR revenues of Rs 581 billion. Other sources of revenues are expected to yield Rs 307 billion higher revenues than originally targeted.

The efforts by the government in restricting the size of the budget deficit to below the initially projected levels must be recognized, as has been done by the IMF. A large primary surplus of over 2 percent of the GDP is likely to be generated in 2024-25.

Turning to the budget estimates for 2025-26, the first impression from the numbers in the IMF staff report is that the federal and provincial budgets for 2025-26 will not be expansionary in character, as in 2024-25. Total expenditure of the federal and provincial governments combined is targeted to increase by only 5.5 percent on 2025-26. This implies a fall in the public expenditure to GDP ratio from 21.6 percent of the GDP in 2024-25 to 20.3 percent of the GDP in 2025-26.

Total current expenditure is anticipated to fall by 1.1 percent of the GDP. Interest payments are expected to be lower by 1 percent of the GDP, with the SBP policy rate down already to only 11 percent. Subsidies and grants are also expected to be lower in absolute terms. Development expenditure is targeted to stay at 2.5 percent of the GDP.

The revenue estimates for 2025-26 are also more on the conservative side. The target growth rate of total revenues in 2024-25 was as high as 40 percent. It has apparently now been set in agreement with the IMF at close to only 15 percent.

FBR revenues were projected to increase substantially by 39 percent in 2024-25. The actual increase is estimated at 32 percent. The big decline is anticipated in federal non-tax revenues in 2025-26. The SBP profits reached a peak level of Rs 2,500 billion in 2024-25. The quantum fall in interest rates implies that they will be much lower in 2025-26. Consequently, non-tax revenues are likely to fall by 33 percent.

Based on low growth rates in total expenditure and total revenues of 5.5 percent and 6.9 percent respectively, the overall budget deficit is expected to show a 1.6 percent only change in magnitude in 2025-26. This implies that it will be 5.1 percent of the GDP in 2025-26, as compared to 5.6 percent of the GDP in 2024-25. The primary surplus will be somewhat lower at 1.6 percent of the GDP.

There is a need for an assessment of the key budgetary magnitudes for 2025-26 in the IMF Staff Report. We focus initially on the expenditure side.

The first key magnitude is the level of defence spending in 2025-26, in the presence of the military confrontation between Pakistan and India. The provision made in the Staff Report is for an increase of 12.2 percent, with the level of expenditure on defense services rising to Rs 2,414 billion. This implies an increase in absolute terms of Rs 262 billion. It is likely that a provision will have to be made for another Rs 300 billion.

The absolute decline of Rs 96 billion in the combined spending on subsidies and grants also appears to be too optimistic. In particular, a provision has to be made for inflation indexation of the cash transfers and increase in the coverage of the Benazir Income Support Programme (BISP), in the presence of almost 110 million people now below the poverty line. Also, the slow pace of privatization of State-Owned Enterprises (SOEs) implies continuing increase in the burden placed on the federal budget by these entities

Overall, it is likely that there has been under-provisioning of federal current expenditure by about 0.7 percent of the GDP, equivalent to Rs 900 billion. This will raise the budget deficit to 5.8 percent of the GDP.

The projected level of revenues is also optimistic in nature. The problem starts with overestimation of FBR revenues in 2024-25 at Rs 12,332 billion. This implies a shortfall in relation to the target of Rs 581 billion. The shortfall has already exceeded Rs 820 billion in the first ten months of 2024-25. The more likely level of FBR revenues in 2024-25 is Rs 11,800 billion.

The targeted level is Rs 14,307 billion of FBR revenues in 2025-26, withthe required growth rate of 21 percent. The normal increase is Rs 1,320 billion, in line with relatively low nominal GDP growth. As such, taxation proposals yielding Rs 1,200 billion will be required in the federal and provincial budgets.

The yield from the agricultural income tax will play a role in achieving this target. The target increase in provincial tax revenues in 2025-26 is Rs 236 billion, including the normal increase. This will have to be increased to Rs 500 billion to target for an increase initially in the yield from the agricultural income tax of Rs 350 billion. The full revenue potential of this tax has been estimated at Rs 880 billion in the recent RASTA project of Pakistan Institute of Development Economics.

However, in the event compliance in terms of payment of the tax is low, there may be a need to introduce withholding taxes, especially on large electricity bills. Further, focus will have to be on broadening the base of the sales tax on services and on development of provincial property-related taxes like the urban immoveable property tax and the capital value tax on property.

Overall, there appears to have been significant underestimation of expenditures and a likely overstatement of FBR revenues in 2025-26. This has led to the estimation of a lower budget deficit in 2025-26. Modification of the numbers in the IMF Staff Report imply that the likely budget deficit in 2025-26 is not 5.1 percent of the GDP, but significantly higher at almost 6.5 percent of the GDP. Consequently, the primary surplus will be a negligible magnitude, and may even turn negative.

The quality of financial management by both the federal and provincial governments will be tested in 2025-26. Already, there appears to be some difficulty in finalizing the budget for 2025-26, as demonstrated by extension of the date for presentation of the federal budget.

Copyright Business Recorder, 2025