EDITORIAL: Pakistan is simultaneously running tight fiscal and monetary policies through primary fiscal surpluses and positive real interest rates. Growth has been compromised as a result of these stabilization efforts.
However, these policies apparently are being pursued in silos, without proper coordination, they are also stoking inflation, which, after declining last year, is on the rise again and has prompted a 100 basis points (bps) increase in the policy rate in the latest monetary policy review by the State Bank of Pakistan (SBP).
The government may pass the buck to the IMF (International Monetary Fund) by arguing that these measures are mandatory under the programme. The real question, however, is why these conditions were accepted in the first place, especially under the Resilience and Sustainability Facility (RSF).
Policy institutes have also highlighted this concern. According to a research paper by the Policy Research and Advisory Council (PRAC), fiscal policy is injecting cost-push inflation through the petroleum levy (PL). Consequently, the SBP is increasing the policy rate to counter inflation which, in turn, hikes the government’s borrowing cost, given that it is by far the largest borrower from the banking system. To keep the fiscal deficit under control, the government then imposes new taxes.
Higher borrowing costs and exorbitantly high tax rates have, overall, discouraged capital formation and kept investment low. The country needs to break this vicious cycle in the upcoming budget.
A few years ago, Pakistan began increasing the petroleum levy to generate federal revenues that do not form part of the divisible pool and therefore are not shared with the provinces. Its yield for the federal government is around 2.5 times more efficient than FBR taxes, 57.5 percent of which have to be transferred to the federating units under the National Finance Commission Award.
Initially, the government increased the petroleum levy while reducing the GST rate on petroleum products to zero. That was understandable, as the PL essentially replaced GST. However, unlike GST, which had a ceiling of 17-18 percent, there is no cap on the petroleum levy. At current prices, the effective levy amounts to around 44 percent of the retail price of petrol and 13 percent for High-Speed Diesel (HSD). This would not have been as problematic had international oil prices remained stable. Yet, while many economies lowered taxes on petroleum products to cushion consumers from global price volatility, Pakistan moved in the opposite direction, transferring a disproportionately high burden onto fuel prices. Today, petroleum prices in Pakistan are among the highest in the region.
This has pushed inflation back into double digits, forcing the SBP to reverse its earlier monetary policy stance and raise the policy rate by 100bps to 11.5 percent. That, in turn, feeds back into the fiscal side of the equation. It is true that roughly half of the increased borrowing cost eventually flows back to the government through taxes on bank profits and interest income, as well as through higher SBP profits. Nevertheless, the remaining burden still has to be financed either through new taxes or cuts in other expenditures.
The story does not end there. Pakistan already has one of the highest GST rates in the region at 18 percent, and there remains a possibility, however slim, that it could be raised to 19 percent. Moreover, many direct taxes are effectively collected in an indirect manner through instruments such as the minimum tax on turnover that goes up to 15% for non-corporate and other levies. All of these costs are ultimately passed on to consumers, adding further to inflationary pressures.
The government needs to rethink its strategy. Otherwise, the stabilization programme will continue to fall short of its objectives. For the fifth consecutive year, GDP growth has remained below 4 percent, while the investment-to-GDP ratio and foreign direct investment (FDI) are languishing at abysmally low levels.
Fiscal and monetary policies should complement each other. If one is required to remain tight, the other should be accommodating. This is not possible when the fiscal policy only views revenues from point of benefit to the federal government alone and accepts conditions of foreign lenders solely to obtain fresh financing.
It is about time the budget, which is likely to be announced tomorrow, revised the current model for federal revenues that is tilted overwhelmingly towards indirect taxes that increase production costs and burden the poor far more than the rich. Any new tax that is imposed or any increase in rate of an existing tax or levy should be evaluated by calibrating its impact on inflation and exchange rate that are the domain of the SBP, which is responsible for monetary policy.
Copyright Business Recorder, 2026
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