Pakistan’s ongoing economic crisis presents a complex tapestry of challenges. On one side, the government must enforce stabilization policies to curb its swelling fiscal deficit and ensure debt sustainability amidst growing political discord. On the other side, it must address pressing external liquidity and funding issues.
Global rating agencies have highlighted these concerns in their assessments of the 2025 budget. Fitch’s latest commentary underscores that while the tax-heavy budget might help the government secure new IMF funding and reduce external pressures, it comes at the expense of economic growth. Fitch forecasts that Pakistan’s fiscal year 2025 budget will markedly diminish government indebtedness, forecasting a reduction to 68% of GDP by the closure of FY24.
This diminution is ascribed to elevated inflation and deflator phenomena, which counterbalance escalating domestic interest expenditures. Fitch Ratings anticipates a concurrent abatement in both inflation and interest expenditures, propelled by economic expansion and primary surpluses. On June 10, the State Bank of Pakistan implemented a pivotal policy shift by slashing policy rates for the first time in half a decade, trimming them by 150 basis points to 20.5%.
This monetary policy realignment is expected to underpin a further diminution in inflation, projected to settle at 12% for FY25, and position the policy rate at 16% by the end of FY25.
The coalition administration unveiled the FY25 budget on June 13, aiming for a headline deficit of 5.9% of GDP and a primary surplus of 2.0%, in contrast to FY24’s estimates of 7.4% and 0.4%, respectively. The budget, marked by substantial tax augmentations and significant fiscal exertions at the provincial level, also aspires to a growth rate of 3.6% in FY25, up from 2.4% in FY24.
Nonetheless, the budget confronts potential opposition within parliament and the broader populace due to the coalition’s less robust mandate from the February elections. Fitch’s revised fiscal projections envisage a primary surplus of 0.8%, accounting for potential revenue deficits and augmented current expenditures, partially offset by diminished development spending. Consequently, the growth forecast for FY25 has been adjusted to 3.0%, down from 3.5%.
Despite these obstacles, the FY24 primary deficit aligns with targets, bolstered by unpopular subsidy reforms that enhance fiscal credibility. While Pakistan has historically struggled to sustain reforms, the absence of viable alternatives has engendered support for stringent policy measures in the short term.
Following the conclusion of its nine-month IMF Stand-By Arrangement in April, significant strides have been made towards a new Extended Fund Facility (EFF), according to the IMF. Pakistan’s external liquidity and funding remain pivotal challenges. A new IMF arrangement is expected to secure additional external funding sources. However, maintaining stringent policy settings to manage external financing needs and comply with a new EFF could prove increasingly arduous.
Since the February elections, Pakistan’s external position has ameliorated. The current account deficit is projected to narrow to 0.3% of GDP ($1 billion) in FY24, down from 1.0% in FY23. Subdued domestic demand has curtailed imports, while exchange rate reforms have bolstered remittance inflows. Robust agricultural exports have also contributed positively. Gross reserves, including gold, have ascended to USD 15.1 billion, covering over two months of external payments, up from USD 9.6 billion at the end of FY23.
Nevertheless, Pakistan’s projected funding needs still surpass its reserves, estimated at approximately $20 billion annually for FY24–FY25, inclusive of maturing bilateral debt expected to be rolled over. This exposes Pakistan to external funding conditions and potential policy missteps. Pakistan’s ‘CCC’ rating, reaffirmed in December 2023, reflects the high external funding risks amid substantial medium-term financing requirements.
Pakistan’s enduring economic predicament is multifaceted. On one front, the government must adopt stabilization measures to rein in its escalating fiscal deficit and ensure debt sustainability amidst escalating political divisions. Concurrently, it must grapple with external liquidity and funding challenges. Global rating agencies have underscored these points in their evaluations of the 2025 budget. Undoubtedly, the tax-laden budget would enable the government to secure new IMF funding, shrink its deficit, and alleviate external pressures. However, this stabilization comes at a cost to growth despite some improvements in short-term economic indicators. Nonetheless, Fitch’s growth forecast of 3% for FY25 remains more optimistic than the 2.3% projected by the World Bank’s Global Economic Prospects report.
Fitch also harbors doubts about the government’s capacity to meet its fiscal objectives; it anticipates that ambitious revenue targets will fall short and current expenditures will exceed budgeted limits. “Our revised fiscal forecasts assume partial implementation and project a primary surplus of 0.8% [against the budgeted 2% from extensive tax hikes] of GDP due to revenue shortfalls and overspending in current expenditures, partially offset by under-execution in development spending,” Fitch states. Positively, it expects economic growth and primary surpluses to gradually reduce the debt-to-GDP ratio. Additionally, a decrease in inflation and interest costs is anticipated for the next year.
Beyond the economic deceleration induced by stabilization measures, Fitch identifies “external liquidity and funding as still Pakistan’s key credit challenges.” Pakistan may secure a new IMF agreement, maintaining the stringent policy settings necessary to manage external financing needs. However, adhering to IMF requirements could become “increasingly challenging,” with projected funding needs around $20 billion, including the rollover of maturing bilateral debt. “This exposes Pakistan to external funding conditions and potential policy missteps. Pakistan’s ‘CCC’ rating reflects high external funding risks amidst elevated medium-term financing requirements,” Fitch adds. This aligns with Moody’s assessment that weak debt affordability heightens debt sustainability risks, as the government allocates over half its revenues to interest payments. Both agencies emphasize that the government’s capacity to sustain reform implementation is crucial to meeting budget targets and unlocking the external financing needed to mitigate liquidity risks that impede growth.
Pakistan stands at a critical juncture, where its ability to navigate economic stabilization and growth simultaneously will be tested. The 2025 budget, with its focus on securing IMF funding and reducing fiscal deficits, sets a challenging path ahead. Fitch’s analysis points to the delicate balance required to meet ambitious fiscal targets and sustain essential reforms. While the outlook for economic growth is cautiously optimistic, the looming challenges of external liquidity and funding underscore the fragile nature of Pakistan’s economic recovery. The government’s commitment to reform implementation will be pivotal in unlocking the external financing needed to alleviate liquidity risks and foster sustainable growth.