Govt agrees to IMF proposal to raise revenue from agriculture, construction sectors

ISLAMABAD: The Federal government has agreed with the International Monetary Fund (IMF) that it will raise additional revenue by targeting undertaxed sectors such as agriculture and construction.

According to Memorandum of Economic and Financial Policies (MEFP) issued by IMF, Parliamentary approval of a FY24 budget in line with IMF staff agreement to meet program targets (Prior Action (PA) for program approval) advances fiscal consolidation through a primary surplus of Rs 401 billion (0.4 percent of GDP) built on a set of credible measures that help sustainably raise additional revenue by targeting undertaxed sectors (such as agriculture and construction), broaden the tax base, and improve progressivity; and (ii) restrain non-priority spending (including through energy sector measures aimed at credibly containing energy sector subsidies, the public wage bill, and pensions) while making fiscal room to protect the generosity level of the Benazir Income Support Programme (BISP) Kafalat program.

In addition, the Pakistani side has also agreed to expand the Personal Income Tax base by another 300,000 persons through the use of data on the withholding tax of  businesses, third-party data, and physical surveys to book new individuals. 

They will also seek to bring the service sector, notably retailers, into the tax net by making better use of data (e.g., from tax collected through electricity bills on commercial connections). Continued progress on the roll-out of track-and-trace will be essential to secure the full benefit of recent taxation changes, notably FED on cigarettes.

The report also disclosed that the circular debt stock to a new historical high of PRs 2.5 trillion (3 percent of GDP), mainly on account of CD flow overruns of Rs 387 billion (0.5 percent of GDP) relative to the Circular Debt Management Plan (CDMP) from early-FY23.

Key drivers were policy slippages (mostly from new unbudgeted, untargeted energy subsidies for exporters and agriculture, and some deferred tariff adjustments for certain residential consumers) and slow progress with structural cost-side reforms. 

Amid mounting liquidity pressures for fuel inputs, debt payments, and capacity charges to independent power producers (IPPs), Pakistan took a set of corrective socially-balanced measures from March 2023 to contain both the FY23 budget subsidy (to 1.1 percent of GDP) and CD flow (to 0.4 percent of GDP). Also enshrined in their cabinet-adopted FY23 CDMP update in February 2023, these measures (worth 0.2 percent of GDP in FY23 alone) not only helped catch up with the deferred tariff adjustments, but also permanently (i) expand the base and level of the debt service surcharge; and (ii) remove all new unbudgetted subsidies.

It also revealed that the CD stock in the gas sector (also including petroleum and late payment fees) has also grown rapidly and is now almost on par with that in the power sector. The main drivers remain below cost-recovery prices from delays in regular biannual tariff adjustments (since September 2020), high operational losses (especially from unaccounted for gas losses (UFG) and collection shortfalls), and uncovered subsidies (especially for export and zero-rated industries).

To avoid burdening the budget with additional subsidies, the authorities implemented a gas price hike in mid-February 2023 (i) of, on average, 75 percent as determined by the Oil and Gas Regulatory Authority (OGRA) in January 2023; and (ii) along an updated tariff slab system, which, developed with the support of the World Bank, ensures full cost recovery, affordability, and efficiency.

The MEFP states that there are 10 (fiscal, social, Monetary and Financial, Energy Sector and State-Owned Enterprises, Climate, Economic Statistics) structural benchmarks including not to grant further tax amnesties, avoid the practice of issuing new preferential tax treatments or exemptions and Issuance by the Central Monitoring Unit (CMU) of its first periodic report on the performance of SOEs, using latest available data, to the Federal Government. In addition, the government has promised the lender that it will notify the annual rebasing (AR) for FY24 to take effect on July 1, 2023 by the end of July 2023.

Moreover, Improve state-owned enterprise (SOE) governance by operationalizing the recently approved SOE law into a policy that clarifies ownership arrangements and the division of roles within the federal governments; and (ii) amending the Acts of four selected SOEs to make the new SOE law fully applicable to those SOEs by end November 2023.

Pakistani authorities have committed that it will not allow supplementary grants for any additional unbudgetted spending over the parliamentary approved level in FY24 at least until the formation of a new government after the elections (except if needed to respond to a severe natural disaster).

In addition, the government will not launch any new tax amnesties or grant further any new tax exemptions in FY24 including through the budget or Statutory Regulatory Orders without prior National Assembly approval.

Moreover, the provincies as per MoU during FY24 will keep primary balance worth Rs401 billion besides government will not introduce any fuel subsidy, or cross-subsidy scheme, in FY23 and beyond to address the challenges of the energy sector. 

The structural benchmark also included compilation and dissemination of Quarterly National Accounts for FY24Q1 and revised annual estimates for FY23.

Pakistan and IMF under FX market functioning agreed that it will will maintain a framework free of restrictions on payments and transfers for current international transactions and MCPs, and, by allowing no hindrance to the market determination of the exchange rate, ensure that no abnormal premium emerges in between the rate in any of the three FX markets— interbank, open, and informal.

The average premium between the interbank and open market rate will be no more than 1.25 percent during any consecutive 5 business day period.  The report stated that real GDP is expected to rebound at a moderate pace in FY24, as the economy gradually stabilizes, supported by favorable base effects from the post-flood recovery, reaching 2.5 percent.

The Headline CPI inflation is projected to remain above 20 percent (yoy) through FY24Q3 as the necessary adjustment of gas and electricity prices, consumption tax increases, and the impact of the currency depreciation pass through the economy.

The report stated that policies under the new program aim to support the authorities’ immediate efforts to stabilize the economy and rebuild buffers.

Key policy pillars include (i) an appropriate FY24 budget to support needed fiscal adjustment; (ii) a return to a market-determined exchange rate and proper functioning of the foreign exchange (FX) market to absorb balance of payment (BOP) pressures and eliminate FX shortages; (iii) adequately tight monetary policy to support disinflation and anchor expectations; and (iv) continuation of structural efforts to strengthen energy sector viability, SOE governance, and the banking sector, while supporting efforts to build Pakistan’s climate resilience.

Resolving Pakistan’s structural changes could help anchor the policy adjustment needed to restore Pakistan’s medium-term viability and capacity to repay.