In a significant stride towards economic stabilization, Pakistan has brokered a 37-month Extended Fund Facility agreement with the International Monetary Fund (IMF). This accord, which hinges on the approval of the IMF Executive Board and assurances from Pakistan’s bilateral development partners, promises to leverage the country’s recent macroeconomic gains while imposing stringent reform measures.

The deal is a double-edged sword, providing much-needed financial relief but also presenting formidable challenges for the government’s reform agenda.

The pivotal triennial, $7 billion aid accord offers a vital lifeline to the financially beleaguered nation. The new scheme is intended to “fortify macroeconomic stability and forge the foundation for more robust, inclusive, and resilient growth,” per an IMF declaration.

Pakistan’s economy, beleaguered by chronic maladministration, has teetered on the precipice, exacerbated by the Covid-19 pandemic, the Ukraine conflict, inflationary pressures from supply chain disruptions, and unprecedented flooding in 2022 that inundated a third of the country. With its foreign exchange reserves dwindling, Pakistan faced a debt debacle, compelling it to seek the IMF’s assistance, securing its inaugural emergency loan in the summer of 2023.

The latest bailout, structured as loans, follows the government’s pledge to enact reforms, notably a concerted effort to expand the nation’s tax base. In a country with a populace exceeding 240 million, where the majority of employment lies within the informal sector, a mere 5.2 million individuals filed income tax returns in 2022. For the fiscal year 2024-25, the Pakistan government aims to amass nearly $46 billion in taxes, a 40 percent surge from the prior year.

“The programme seeks to build upon the hard-earned macroeconomic stability achieved over the past year by intensifying efforts to bolster public finances, mitigate inflation, rebuild external buffers, and eliminate economic distortions to stimulate private sector-led growth,” the IMF statement conveyed, citing Nathan Porter, the Fund’s mission chief to Pakistan.

“In this context, the authorities intend to augment tax revenues through measures equating to 1.5 percent of GDP in FY25 and 3 percent of GDP throughout the programme,” it elaborated. The revenue enhancement will be attained through “simplified and equitable direct and indirect taxation, incorporating net income from retail, export, and agriculture sectors into the tax system properly.”

The statement further articulated that federal and provincial administrations have consented to rebalancing fiscal activities consistent with the 18th Constitutional Amendment by endorsing a ‘National Fiscal Pact.’ Under this pact, sectors such as education, health, social protection, and regional public infrastructure investment will be decentralized to provincial governance.

Provinces have already vowed to “fully harmonize their Agricultural Income Tax regimes through legislative amendments” with the federal and corporate tax structures. This policy will be effective from January 1, 2025. The government will also enhance the power sector’s sustainability and curtail its losses through timely tariff adjustments, reforms, and averting any unwarranted expansion of generation capacity.

“The authorities remain devoted to executing targeted subsidy reforms, substituting cross-subsidies to households with direct and targeted Benazir Income Support Programme (BISP) assistance.” Additionally, the authorities will refine the operations and management of state-owned enterprises (SOEs) alongside privatization initiatives, prioritizing the most profitable entities. The government is also progressing towards “phasing out” incentives for Special Economic Zones, agricultural support prices, and associated subsidies, while eschewing new regulatory or tax-based incentives or any guaranteed returns “that could skew the investment landscape.” Furthermore, the authorities have committed to advancing anti-corruption, governance, and transparency reforms, and gradually liberalizing trade policy, the statement concluded.

However, Prime Minister Shehbaz Sharif’s budget for the current fiscal year has ignited vehement dissent against his administration domestically.

While the government managed to surmount the initial hurdle toward the agreement by imposing severe direct and indirect taxes on the urban middle class, the new program objectives will continue to challenge its dedication to reforms throughout the duration of the deal. Initially, the IMF mandates the authorities to target under-taxed sectors, ensuring proper taxation of exporters, retailers, and agriculturists to sustain fiscal consolidation and augment tax revenues by measures amounting to 3.5% of GDP. The current budget already endeavors to elevate tax revenues by 1.5% of GDP to achieve the program’s goal of a 1% primary surplus this year.

Another contentious stipulation involves abolishing agricultural support prices, particularly for the staple wheat crop, and related subsidies. The protests by farmers after wheat prices plummeted due to the state’s refusal to purchase their surplus. The statement implies that the government has also consented to phasing out incentives for Special Economic Zones and abstaining from new regulatory and tax-based incentives or any guaranteed returns that could distort the investment landscape, including projects channeled through the army-led SIFC, to create an equitable playing field for all businesses. The impact on SIFC’s efforts to attract investments from ‘friendly’ nations remains uncertain.

Other program objectives — periodic adjustments of power and gas prices, reforms in SOE governance and privatization, transferring more fiscal responsibility to provinces, and market-based monetary and exchange rate policies — essentially represent the unfinished agenda of previous programs. Although the agreement has provided the government with much-needed breathing space, it has also introduced significant political challenges.

While most reforms agreed with the Fund are crucial for future debt sustainability, others will severely impact economic growth and new investments, at least in the short term. The country’s financial team may feel relieved after securing the deal, but they must remember that they have only delayed the inevitable. If this respite is not transformed into an opportunity, the challenges facing the economy will soon multiply.

While the IMF agreement offers a critical lifeline to Pakistan’s struggling economy, it is not without its challenges. The government’s ability to navigate the reform landscape and meet the stringent targets set by the IMF will be pivotal in determining the country’s economic trajectory. The temporary relief granted by this deal must be transformed into sustainable growth opportunities. Failure to do so will only exacerbate the economic issues, compounding the challenges that lie ahead. The success of this accord will ultimately depend on the government’s commitment to implementing the necessary reforms and leveraging this opportunity for long-term economic stability.