The federal budget of FY2025-26

The federal budget for 2025-26 has been announced recently. This has led to wide-ranging discussions in the media about the issues not addressed or focused on in the budget, the quality and yield from taxation measures to achieve the revenue targets and the appropriateness of the revealed expenditure priorities.

However, there is need to focus first on the budgetary outcome in 2024-25. There is, no doubt, that this has been an exceptionally good year. The outcome of the size of the consolidated budget deficit is 5.6 percent of the GDP. This is lower than the targeted deficit of 5.8 percent of the GDP at the start of the year. Seldom has this happened.

Also, there has been a big reduction in the budget deficit in 2024-25 of 1.2 percent of the GDP in relation to the level in 2023-24. This will ensure less rapid increase in the public debt. There is need to commend and appreciate the better management of public finances by both the federal and the provincial governments.

Throughout the year, the growing deficit in FBR revenues in relation to the target level was being highlighted. Despite the eventual shortfall of Rs 1070 billion, how has the budget deficit target been more than achieved? This is due to a reduction in current expenditure in relation to the target level by over Rs 800 billion, due primarily to a big containment in debt servicing, with the sharp fall in interest rates. Further, the spending on PSDP projects has been restricted by over Rs 540 billion.

Turning to the budget for the forthcoming financial year, we look forward to the same quality of financial management. There is, in fact, an ambitious commitment to bring down further the consolidated budget deficit to 3.9 percent of the GDP. This will imply a quantum reduction of 1.7 percent of the GDP in relation to this year’s deficit. If achieved, it will be one of the lowest budget deficits over the last many years. Also, the primary surplus will remain high at above 2 percent of the GDP.

The fundamental question is how this target of big deficit reduction will be achieved in 2025-26? The FBR revenue target has been set at Rs 14,131 billion, as compared to the level of Rs 11,900 billion in 2024-25. The more likely outcome is Rs 11,700 billion, with a significant shortfall also in June 2025. Therefore, the required growth rate in FBR revenues is 20.8 percent.

An optimistic projection of the GDP in nominal terms in 2025-26 is 12.6 percent. This will require growth rate of 4.2 percent in the real GDP and the rate of inflation at 7.5 percent. The elasticity of FBR revenues with respect to the growth in nominal GDP is close to 1. Therefore, with no change in tax system FBR revenues can increase by almost 12.6 percent and reach Rs 13,170 billion.

The gap in relation to the target will still be a sizeable Rs 961 billion. This will require improvements in tax administration and taxation measures in terms of higher tax rates and less exemptions in the federal budget to yield the required Rs 961 billion. The first impression from the Finance Minister’s speech is that this is unlikely to be the case.

Non-tax revenues are expected to rise by 5 percent to Rs 5,147 billion in 2025-26. The year, 2024-25, actually witnessed a big peak in non-tax revenues, because of Rs 2500 billion of SBP profits accruing to the federal government. This was clearly a reflection of the extraordinarily high level of the policy rate at 22 percent earlier.

The big surprise is that the federal non-tax revenues in 2025-26 are based on the assumption that the largest source of SBP profits will remain unchanged at Rs 2500 billion. This is unlikely, given the big fall in the policy rate in 2024-25 to 11 percent.

The IMF estimate in the Staff Report of the 17th of May is that non-tax revenues will be Rs 3,685 billion in 2025-26. This is substantially lower by Rs 1462 billion in relation to the governments’ budget estimate and is based on substantially lower SBP profits in 2025-26.

The likely overstatement of the non-tax revenues, due especially to overstatement of SBP profits, is an issue which needs to be resolved. It implies that the budget deficit target of 3.9 percent of the GDP in 2025-26 is perhaps understated by as much as 1.1 percent of the GDP.

The other perhaps surprising magnitude is that of federal current expenditure projected at Rs 16,286 billion in 2025-26, which is actually lower than the magnitude in 2024-25 by Rs 102 billion. Given the rate of inflation projection of 7.5 percent, the costs of running government could be significantly higher and the drop is unlikely.

The containment of current expenditure is based primarily on a big reduction in debt servicing of Rs 738 billion, 8.3 percent lower in relation to the level in 2024-25. Presumably, this is based on a further significant drop in interest rates in the economy in 2025-26, which remains to be seen.

The other expenditure head in which a drop in expenditure in 2025-26 is anticipated is in subsidies of Rs 192 billion, equivalent to containment by 14 percent. Here again, the optimism is probably based on the assumption that the power sector will begin to perform much better and the quantum of subsidies will be significantly reduced by Rs 154 billion. Hopefully, this does not mean a more aggressive policy on electricity tariffs.

The level of grants is being increased by Rs 167 billion to Rs 1928 billion in FY 2025-26. However, within this expenditure is the outlay on the BISP programme. This is targeted to rise by Rs 124 billion in 2025-26. Consequently, there will not be much fiscal space left for other types of grants, particularly to the special regions.

There is need to recognize the special needs for security arrangements linked to the possibility of a confrontation once again between Pakistan and India. There is an appropriate increase in the budgetary outlay for defense services of Rs 369 billion, equivalent to a growth rate of 16.9 percent. Also, the provision for emergency has been rightly increased by over 74 percent to Rs 389 billion next year.

The real disappointment is the proposed allocation of Rs 1287 billion for development spending. This includes the expenditure on development projects in the PSDP of Rs 1000 billion and loans of Rs 287 billion, mostly to the provincial governments.

The implied size of the federal PSDP is close to be only 0.8 percent of the GDP. This is an extremely small size of federal development expenditure on key infrastructure, which includes power transmission and distribution, water resourcesand highways. A decade ago, the federal PSDP used to be over 2 percent of the GDP.

A new priority has emerged since the unilateral withdrawal of India from the Indus Basin Waters Treaty. Pakistan must focus on quick augmentation of its water resources in the next few years, given the risk of steps being taken by India to divert water away from Pakistan.

Currently, there are 67 on-going projects in the water resources sector of the federal PSDP. The total cost of these projects is as much as Rs 2,440 billion. The allocation and expenditure this year is close to Rs 185 billion. It is truly amazing that there has been a cutback proposed for spending on water projects to Rs 133 billion. At the minimum, the allocation should have been raised to 15 percent of the costs, amounting to Rs 366 billion. This will raise the federal PSDP to Rs 1250 billion, equivalent to almost 1 percent of the GDP.

Clearly, the massive proposed reduction in the budget deficit from 5.6 percent of the GDP to 3.9 percent of the GDP could be moderated and the deficit target increased to 4.5 percent of the GDP. This will still be below the IMF expectation of a budget deficit of 5.1 percent of the GDP in 2025-26. The additional fiscal space of 0.6 percent of the GDP of Rs 775 billion can be used for raising the PSDP by Rs 400 billion and the BISP by Rs 375 billion.

Overall, the 2025-26 federal budget is too contractionary in nature. It targets for too big a deficit reduction. Also, the target of FBR revenues has to be justified by detailed quantification of the revenues from taxation measures and from stronger tax enforcement. More fiscal space needs to be created for larger outlays on water resource projects and the Benazir Income Support Programme.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2025