Presently, Pakistan’s economy is grappling with the formidable challenge of achieving fiscal sustainability. During FY23, the government generated a total revenue of Rs9.64 trillion, equivalent to 11.4 per cent of GDP. In contrast, its consolidated expenditure soared to Rs16.2tr, accounting for 19.1pc of GDP, resulting in a substantial fiscal deficit of Rs6.5tr, or 7.7pc of GDP.

Notably, a significant portion of this expenditure was allocated to debt servicing, which reached Rs5.7tr, equivalent to 6.7pc of GDP. The enormity of this deficit necessitated the government to resort to costly borrowing, exacerbating the already mounting debt levels.

Moreover, Pakistan experienced a primary deficit of 1pc of GDP during the same period, revealing that even after excluding debt servicing, the government was unable to cover its expenditures solely from its revenues.

The situation takes a more ominous turn when accounting for the current account deficit of $2.24 billion during the same period, coupled with depleting foreign reserves. The combination of these factors paints a concerning picture of Pakistan’s fiscal health.

A narrow base, exemptions for influential sectors and a substantial informal economy contribute to the feeble capacity of the tax machinery

As of June 30, 2023, Pakistan’s gross debt has surged to Rs62.9tr, equivalent to 74.3pc of its GDP, while the total debt and liabilities have reached Rs76.1bn, constituting approximately 90pc of GDP. This extensive financial burden encompasses Rs38.8tr in domestic debt and Rs35.7tr in external debt and liabilities.

In the last financial year, concerns about a potential default without the International Monetary Fund’s (IMF) support were widespread, primarily due to the necessity of repaying approximately $73bn in external loans within a tight three-year window from July 2023 to June 2026.

Pakistan entered IMF’s standby arrangement in July 2023 to navigate this precarious fiscal situation, securing $3bn. This move reflects the urgent need for external support to bolster the country’s financial stability and manage its escalating debt-related challenges.

A primary factor contributing to Pakistan’s fiscal imbalance is the low tax-to-GDP ratio compared to other developing nations. Currently, Pakistan’s tax revenue stands at approximately 10pc of GDP, lagging behind the 15-20pc range observed in lower- and middle-income countries.

Remarkably, the federal government shoulders the bulk of tax collection responsibilities, accounting for nearly 90pc, while the provincial contribution to revenue collection remains at a mere 10pc.

As of June 2023, a mere 4.2 million individuals are active taxpayers who filed tax returns, a stark contrast to the 67m-strong employed labour force documented in the last labour force survey of 2021. This glaring disparity highlights a pervasive issue of poor tax compliance.

The underlying causes of this deficiency in tax revenue encompass a narrow tax base, tax exemptions granted to influential sectors, the prevalence of a substantial informal economy, the feeble capacity of the tax machinery, and an inadequate tax structure.

Addressing these issues becomes imperative for fostering fiscal stability and ensuring a more equitable distribution of the tax burden across the economic spectrum. Implementing reforms to broaden the tax base, curtailing exemptions for powerful sectors, strengthening tax administration capabilities, and improving the overall tax structure are pivotal steps that must be considered to enhance revenue generation and fortify Pakistan’s fiscal foundation.

Conversely, the government faces challenges in aligning its expenditures with the available resources. The burgeoning debt-servicing obligations, substantial costs associated with running the civil government, including pension liabilities, untargeted subsidies specifically in agriculture and the power sectors, and significant losses incurred by state-owned enterprises constitute major components of government spending.

The implementation of the 18th Amendment resulted in the devolution of 17 subjects/ministries to the provinces. Similarly, the 7th National Finance Commission (NFC) Award shifted a considerable share of revenue to the provinces. Despite this devolution of resources, the federal government continues to allocate funds to subjects that are now legally the responsibility of the provinces.

This misalignment places a substantial burden on the federal budget, compelling the government to resort to expensive borrowing to bridge the resulting financial gap.

Addressing this fiscal mismanagement is crucial for achieving a more sustainable and balanced budget. Streamlining expenditures, particularly in areas now under provincial jurisdiction, and enhancing coordination between federal and provincial authorities can contribute to a more efficient allocation of resources and alleviate the strain on the federal budget. Such measures are essential for reducing dependency on costly borrowed funds and fostering a more prudent fiscal environment.

Achieving fiscal sustainability in Pakistan demands a comprehensive and profound overhaul through broad-based structural reforms. To carve out fiscal space for essential expenditures, the government must elevate its revenue to at least 15pc of GDP.

This necessitates broadening the tax base by encompassing untaxed individuals, eliminating tax exemptions in sectors like property, retail/wholesale, and agriculture, and streamlining tax compliance procedures for simplicity.

The writer is a PhD (Economics) Scholar at the Pakistan Institute of Development Economics, Islamabad

Published in Dawn, The Business and Finance Weekly, February 12th, 2024