Budget with mixed signals

This is a contractionary budget, aimed at delivering a consolidated fiscal deficit of 3.9 percent of GDP—the lowest in sixteen years—and a primary surplus of 2.4 percent, the highest ever recorded. But while these targets are commendable on paper, the budget itself lacks coherence and vision. Token reductions in some tax rates — naively branded as reform—are offset by new or higher taxes to plug revenue gaps. The net effect is neutral, if not regressive.

The real problem is the absence of serious thinking. One area that held some promise was tariff reform—hailed by the finance minister as Pakistan’s “East Asian moment.” But upon closer inspection, the reform appears cosmetic. It gestures in the right direction but lacks depth.

An analysis at the HS 6-digit level, using data from the FBR and World Bank, offers a more granular view. Without getting lost in technicalities, it is clear that the focus is on reducing duties on final goods rather than intermediates — a policy choice that risks undermining the goal of boosting domestic production. For reforms to be meaningful, tariff cuts must target protected intermediates, not already-liberalized consumer imports.

Trade economists are divided. The architect of the National Tariff Policy sees this as one of the most ambitious liberalizations globally in two decades. Others argue it is underwhelming — limited in scope, lacking institutional clarity, and failing to dismantle entrenched rent-seeking structures.

A telling example is the automotive sector. The government has paused further tariff cuts for one year, citing obligations to new entrants under the auto policy, which expires in June 2026. While this may be a necessary compromise, there is room to reduce duties on other segments — especially luxury imports. The broader challenge remains unaddressed: Pakistan continues to rely on a maze of customs and regulatory duties to protect inefficient sectors. Unless this architecture is dismantled, reform credibility will remain in doubt.

The stated goal of ending anti-export bias and curbing rent-seeking is valid. But duty reductions alone will not get us there. Complementary measures — such as lowering income and sales tax rates, particularly those collected at the import stage—are critical. A real test would be to let the currency adjust — a politically fraught but economically necessary move.

Investment cannot rise without savings, and both are missing from this budget. The finance ministry argues that holding the line on stock market taxation promotes capital formation. That is spin. In reality, tax policy continues to disincentivize genuine long-term savings.

For instance, the proposed removal of limit of 50 percent tax-free withdrawal from voluntary pension scheme at retirement would put this much needed retirement scheme in jeopardy. A proposal by the SECP (Securities and Exchange Commission of Pakistan) to grant tax pass-through status to private equity and venture capital funds — if ninety percent of income is distributed — was also rejected. These moves collectively hurt capital formation.

At the same time, taxes on bank deposit income have been raised by one-third (from 15 to 20 percent), and on fixed-income mutual funds from 15 to 25 percent. Meanwhile, capital gains and dividend taxes on stock market instruments remain untouched. While keeping capital market taxes low may be justifiable, penalising other formal savings channels — especially for risk-averse savers—is counterproductive. It reflects a dangerous overreliance on the KSE-100 index as a political scoreboard. The stock market is not a substitute for long-term capital formation.

The government is also trying to stimulate the real estate market by lowering transaction taxes. This could spark short-term activity, but risks overheating imports and reigniting balance-of-payments pressures. Again, the focus is on short-term wins over long-term sustainability.

The “war on cash” slogan rings hollow when the tax treatment of digital payments is worse than cash-on-delivery. E-commerce vendors are required to register and withhold taxes, while digital transactions are subject to higher rates. This sends mixed signals — undermining financial digitization while pretending to promote it. Then there is the budget math — questionable at best.

SBP profit transfers are projected at Rs2.5 trillion, unchanged from last year. But based on 10MFY25 data, profits could be down by 23 percent—implying a shortfall of Rs500–600 billion. The government has also budgeted Rs1.5 trillion from the Petroleum Levy, but given geopolitical tensions and elevated oil prices, this projection is risky. On the tax side, the FBR is banking on Rs400 billion from enforcement and tax broadening — ambitious, if not unrealistic.

The finance minister has hinted that if enforcement powers are not enhanced, additional revenue measures may be introduced. Realistically, these measures may come either way. If they do, the fiscal noose will tighten further, entrenching austerity and prolonging the growth slump for yet another year.

Copyright Business Recorder, 2025