PAKISTAN DEVELOPMENT UPDATE

Restoring Fiscal Sustainability

October 2023
Preface

The World Bank Pakistan Development Update (PDU) provides an update on the Pakistani economy, its economic
outlook, the development challenges the country faces, and the structural reforms that should be considered.

This edition of the PDU was prepared by Macroeconomics, Public Sector, Trade, and Investment Global Practice
under the guidance of Najy Benhassine (Country Director, SACPK), Mathew Verghis (Regional Director, ESADR),
Shabih Ali Mohib (Practice Manager, ESAC1), Ximena Del Carpio (Practice Manager, ESAPV), and Tobias Akhtar
Haque (Lead Country Economist and Program Leader, ESADR). The core PDU team was led by Aroub Farooq
(Economist, ESAC1) and includes Adnan Ashraf Ghumman (Senior Economist, ESAC1), Derek H.C. Chen (Senior
Economist, ESAC1), Mukhtar Ul Hasan (Economist, ESAC1), Sayed Murtaza Muzaffari (Economist, ESAC1),
Fahad Hasan (Financial Sector Specialist, ESAF1), Maria Qazi (Economist, ESAPV), Moritz Meyer (Senior
Economist, ESAPV), Christina Wieser (Senior Economist, ESAPV), Florian Blum (Senior Economist, EECM2),
Qurat ul Ain Hadi (Financial Management Specialist, ESAG1), Arsianti (Consultant, ESAC1), and Ali Shahid (Team
Assistant, SACPK). The report benefited from detailed inputs from Shabih Ali Mohib (Practice Manager, ESAC1),
and Tobias Akhtar Haque (Lead Country Economist and Program Leader, ESADR). The report was edited by
Andrea Scheibler.

The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the
Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee
the accuracy of the data included in this work. The data cut-off date for this report was September 6, 2023. The
boundaries, colors, denominations, and other information shown on any map in this work do not imply any
judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or
acceptance of such boundaries.

The photograph for the front cover is by Aqib Yasia/ www.shutterstock.com.

To receive the PDU and related publications by email, please email [email protected]. For questions and
comments, please email [email protected].
Table of Contents

PREFACE ................................................................................................................................ II

TABLE OF CONTENTS ...................................................................................................... III

LIST OF FIGURES, TABLES, AND BOXES .......................................................................IV

LIST OF ABBREVIATIONS AND ACRONYMS ................................................................. V

1. EXECUTIVE SUMMARY .................................................................................................... 1

2. RECENT ECONOMIC DEVELOPMENTS...................................................................... 4

a. Context .......................................................................................................................................... 4
b. Real Sector .................................................................................................................................... 4
Growth .......................................................................................................................................... 4
Inflation ........................................................................................................................................ 5
Poverty .......................................................................................................................................... 7
c. Monetary and Financial Sector ..................................................................................................... 8
Monetary ....................................................................................................................................... 8
Financial Sector ............................................................................................................................ 8
d. External Sector .............................................................................................................................. 9
e. Fiscal and Debt Sustainability .....................................................................................................11
f. Medium-Term Outlook ............................................................................................................... 13
g. Risks and Priorities ..................................................................................................................... 15
3. RESTORING FISCAL SUSTAINABILITY ...................................................................... 17

a. Introduction ................................................................................................................................ 17
b. Pakistan’s Fiscal Deficits and Debt Accumulation .................................................................... 17
c. Revenue Mobilization Challenges............................................................................................... 18
d. Expenditure Management Challenges ....................................................................................... 20
e. Debt Management Challenges .................................................................................................... 23
f. Fiscal Federalism Challenges ...................................................................................................... 25
g. Roadmap for Addressing Fiscal Constraints .............................................................................. 26
REFERENCES ....................................................................................................................... 29

ANNEX ................................................................................................................................... 31
List of Figures, Tables , and Boxes

FIGURES

Figure 2.1: Contribution to Headline Inflation in Urban Areas........................................................ 6

Figure 2.2: Contribution to Headline Inflation in Rural Areas ......................................................... 6
Figure B.2.1: Stock of Outstanding OMOs ....................................................................................... 7
Figure B.2.2: Monetary Base and Inflation ....................................................................................... 7
Figure 2.3: Annual Current Account Balances.................................................................................. 9
Figure 2.4: Annual Trade Balances ................................................................................................... 9
Figure 2.5: Consolidated Fiscal Balance (excluding grants) .......................................................... 12
Figure 2.6: Primary and Revenue Balance (excluding grants) ....................................................... 12
Figure 3.1: Pakistan: General Government Budget Balance........................................................... 18
Figure 3.2: South Asia: General Government Budget Balance ....................................................... 18
Figure 3.3: Credit to the Private Sector ........................................................................................... 18
Figure 3.4: Total Revenue, by source and year ............................................................................... 19
Figure 3.5: Tax Revenue, by source and year ................................................................................. 19
Figure 3.6: Recurrent and Development Expenditure .................................................................... 21
Figure 3.7: Federal Government Spending, Economic Classification ............................................ 21
Figure 3.8: Pakistan’s Public and Publicly Guaranteed Debt ......................................................... 23
Figure 3.9: General Government Debt to GDP ............................................................................... 23
Figure 3.10: Drivers of Pakistan’s Public and Publicly Guaranteed Debt ...................................... 24

TABLES

Table ES.1: Projections of Key Economic Indicators ....................................................................... 2

Table 2.1: Real GDP Growth ............................................................................................................. 5
Table 2.2: Balance of Payments Summary1 ..................................................................................... 10
Table 2.3: Summary of Fiscal Operations ....................................................................................... 13
Table 2.4: Pakistan Macroeconomic Outlook (FY20–25) ............................................................... 15
Table 3.1: Policy Recommendations ............................................................................................... 26

BOXES

Box 2.1: Pressing the Brake and Accelerator at the Same Time! ...................................................... 7
List of Abbreviations and Acronyms

BISP Benazir Income Support Programme

BPS Basis Points
CAD Current Account Deficit
CAR Capital Adequacy Ratio
CCI Council of Common Interests
CIT Corporate Income Tax
CLL Concurrent Legislative List
CPI Consumer Price Index
DMIS Debt Management Information System
DMO Debt Management Office
EFF Extended Fund Facility
FBR Federal Board of Revenue
FDI Foreign Direct Investment
FRDLA Fiscal Responsibility and Debt Limitation Act
FY Fiscal Year
GDP Gross Domestic Product
GST General Sales Tax
HIES Household Integrated Economic Survey
IMF International Monetary Fund
Kwh Kilowatt Hour
LSM Large-Scale Manufacturing
NEC National Economic Council
NFC National Finance Commission
NPL Non-Performing Loan
OMO Open Market Operation
PDL Petroleum Development Levy
PDU Pakistan Development Update
PFM Public Financial Management
PKR Pakistani Rupee
PPP Purchasing Power Parity
PSDP Public Sector Development Programme
QTA Quarterly Tariff Adjustment
SBA Stand-By Arrangement
SBP State Bank of Pakistan
SME Small and Medium Enterprise
SOE State-Owned Enterprise
TSA Treasury Single Account
UIPT Urban Immovable Property Tax
Y-o-Y Year-on-Year
 Restoring Fiscal Sustainability Pakistan Development Update

1. Executive Summary
Amid stagnant Pakistan’s strong post-pandemic recovery came to a halt in fiscal year (FY)23 with the
growth, Pakistan delayed withdrawal of COVID-19-era policy stimulus leaving large accumulated
faces exceedingly economic imbalances. Pressures on domestic prices, external and fiscal balances, the
high economic risks exchange rate, and foreign exchange reserves mounted amid surging world commodity
prices, global monetary tightening, recent catastrophic flooding, and domestic political
uncertainty. Confidence and economic activity collapsed due to import and capital
controls, periodic exchange rate controls, creditworthiness downgrades, and ballooning
interest payments. Amid shrinking economic activity, price shocks, and the impacts of
flooding, poverty increased significantly. The approval of the International Monetary
Fund (IMF) Stand-By Arrangement (SBA) in July 2023 unlocked new external financing
and averted a balance of payments crisis. However, underlying imbalances and structural
constraints remain to be addressed. Short-term macroeconomic stability will depend on
the robust implementation of the SBA and continued fiscal restraint and external
financing inflows. Without further reforms, risks will remain exceptionally high, economic
activity will remain constrained by import controls and weak confidence, while low
investment will undermine medium-term growth potential. A more robust medium-term
recovery will require the implementation of significant medium-term reforms to improve
the quality of expenditures, broaden the tax base (including increased taxes on agriculture,
retail, and property, and improved administration), address regulatory constraints to
private sector activity, reduce the distortive presence of the state in the economy, and
address inefficiencies and high costs in the energy sector. Election-related policy slippages
and new domestic or external shocks also pose major risks to the external balance and
financial sector stability.

Economic activity Economic activity slowed sharply in FY23 with contractions in both industry and services
contracted in FY23 sectors and muted growth in the agriculture sector. Overall, real gross domestic product
(GDP) is estimated to have declined by 0.6 percent in FY23 after growing by 6.1 percent
in FY22 and 5.8 percent in FY21. Floods caused heavy damage to crops and livestock,
while difficulties securing critical inputs, including fertilizers, further slowed agriculture
output growth. Supply chain disruptions due to import restrictions and flood impacts,
high fuel and borrowing costs, political uncertainty, and weak demand affected industry
and service sector activity, and dampened private investment. Public consumption and
investment contracted in line with fiscal consolidation. Private consumption also shrank
with weakened labor markets and surging inflation.

Monetary policy was Headline inflation rose to a multi-decade high in FY23, averaging 29.2 percent year-on-
tightened in year (y-o-y) compared to 12.2 percent in FY22. Main drivers included flood-related
response to a surge disruptions to agricultural production and supply chains, energy tariff and petroleum price
in inflation adjustments, and depreciation of the Rupee. In response to rising inflation, the State Bank
of Pakistan (SBP) continued to hike the policy rate, increasing it by a cumulative 825 basis
points (bps) to reach 22.0 percent in FY23. Despite this, monetary policy remained
accommodative with negative real interest rates.

Poverty increased Amid slowing growth and high inflation, the poverty headcount is estimated to have
with record high reached 39.4 percent in FY23—more than 5 percentage points higher than in FY22.1 The
inflation, wide-scale record high food and energy prices, lower labor incomes, and the loss of crops and
damages from the livestock due to the 2022 floods significantly impacted real household incomes. Despite
floods, and weak a temporary increase in cash transfers and one-time fuel subsidy, overall mitigation
labor markets measures were insufficient to protect poor and vulnerable households.

Despite a narrower Pakistan’s external position weakened in FY23 due to tight global financing conditions,
CAD, the external large amortization payments, and loss of investor confidence limiting new foreign inflows.
position weakened The current account deficit (CAD) narrowed to 0.7 percent of GDP in FY23, from 4.7

1 Both FY22 and FY23 poverty estimates are based on World Bank projections. The last Household Integrated Economic Survey (HIES)
that allowed accurate measurement of poverty took place in 2018. A new survey is needed to update the poverty headcount.

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 Restoring Fiscal Sustainability Pakistan Development Update

percent of GDP in FY22.2 This was primarily due to import management measures, a
weaker currency, and muted economic activity that caused imports to decline faster than
exports, supporting a narrower trade deficit. Meanwhile, official remittance inflows
declined by 13.6 percent y-o-y, partly due to rigidities in the official exchange rate
incentivizing the use of informal remittance channels. Amid large amortization payments
and capital outflows, the financial account also turned negative driving the overall balance
of payments into a slight deficit. The SBP’s gross foreign exchange reserves fell to US$5.7
billion, equivalent to only one month of imports at end-June 2023.3 Given the high
external pressures, by end-June 2023 the Rupee had depreciated by 28.6 percent against
the US dollar.

High interest Despite significant narrowing of the primary deficit, the consolidated fiscal deficit,
payments caused excluding grants, declined only marginally to 7.8 percent of GDP in FY23, from 7.9
fiscal pressures percent in FY22.4 This was due to a substantial increase in interest payments on the back
of the higher domestic policy rate and weakening currency. The primary deficit declined
to 0.8 percent of GDP in FY23, from 3.1 percent in FY22, supported by lower public
spending on subsidies and grants. Muted economic activity and a decline in imports
suppressed revenue from indirect taxes, limiting the Government’s capacity to increase
tax revenue. The Government financed the resulting fiscal deficit primarily through
borrowing from commercial banks, further crowding out private sector borrowing.
Although the banks’ capital adequacy ratio (CAR) at end-FY23 remained largely
unchanged in comparison to end-FY22, financial sector risks rose with the larger
exposure to the sovereign and a slight increase in non-performing loans. By end-FY23,
public debt, including guaranteed debt, rose to 82.3 percent of GDP from 80.7 percent
of GDP at end-FY22.

The pace of Careful economic management—including exchange rate flexibility, fiscal restraint, and
economic recovery maintaining implementation of the FY24 budget and the IMF-SBA—will be required to
will be limited by ensure macroeconomic stability this fiscal year. Even with these measures, the current
external sector economic trajectory is not sustainable without further fiscal adjustment and other
constraints, with very reforms. The foreign exchange position continues to erode, despite the new IMF
high risks program, rollovers, refinancing, and new inflows from official creditors. The persistent
exchange rate depreciation and inflationary pressures continue to weigh on economic
activity. Selective import controls will be required to preserve scarce foreign exchange
reserves, constraining the pace of economic recovery with continued supply chain
disruptions. Confidence remains extremely weak. Economic growth is therefore expected
to remain below potential over the medium term with limited improvements in
investment and exports. With depleted policy buffers, the economy’s capacity to
overcome any fresh domestic or external shock remains limited; downside risks to the
outlook are therefore very high.
Table ES.1: Projections of Key Economic Indicators
FY20 FY21 FY22 FY23e FY24f FY25f
Real GDP Growth, at factor cost -0.9 5.8 6.1 -0.6 1.7 2.4
Current Account Balance (% of GDP) -1.5 -0.8 -4.6 -0.7 -1.4 -1.5
Fiscal Balance (% of GDP), excluding grants -7.1 -6.1 -7.9 -7.8 -7.7 -7.6
Public Debt, including govt. guaranteed debt (% of GDP) 84.0 77.6 80.7 82.3 72.4 70.3
Sources: Data from the Pakistan Bureau of Statistics, State Bank of Pakistan, Ministry of Finance, and World Bank staff estimates.
Notes: e = estimate; f = forecast. This macroeconomic outlook was prepared by World Bank staff and differs from that of the Government,
including real GDP growth estimates for FY23. Indicators are reported as share of World Bank estimated GDP for FY23.

Real GDP growth Under a baseline scenario, where the fiscal deficit is effectively contained but little
will remain low over progress is made with broader structural reforms, growth will remain sluggish and risks
the medium term will remain exceptionally high. Real GDP growth is projected to reach only 1.7 percent
in FY24 and 2.3 percent in FY25 (Table ES.1). The agriculture sector is expected to
recover on the back of higher production of important crops, including cotton and rice.

2 The CAD in FY23 is reported as share of World Bank estimated GDP for FY23.
3 Based on World Bank import projections for FY24.
4 Primary and fiscal deficits in FY23 are reported as share of World Bank estimated GDP for FY23.

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 Restoring Fiscal Sustainability Pakistan Development Update

Marginal easing of import restrictions is expected to support some recovery in the

industrial sector, particularly large-scale manufacturing. Flow-on impacts from the
strengthening agriculture and industrial sectors will support a revival in associated services
sectors including wholesale and retail trade, and transport and storage. However, high
inflation due to increasing domestic energy prices and continued depreciation is likely to
keep economic activity subdued. Recovery in private investment and exports will be
marginal in the absence of broader reforms.

The CAD is The CAD is expected to widen to 1.4 percent of GDP in FY24 and further to 1.5 percent
expected to widen in FY25, primarily on account of higher imports. The phased and gradual easing of import
marginally restrictions is expected to lift imports, in part due to pent-up demand from the previous
fiscal year. Inflows of critical imported inputs will also support major export-oriented
sectors, include textiles. Growth in imports is expected to exceed growth in exports,
leading to a wider trade deficit. Meanwhile remittances are expected to decline marginally,
in part due to slower growth in host countries.

Despite fiscal With the slight recovery in revenue partly due to the resumption of growth and imports,
consolidation, the and continuation of expenditure restraint, the primary deficit is expected to remain
overall fiscal deficit modest, declining to 0.4 percent of GDP in FY24 and further to 0.3 percent in FY25.
is expected to remain However, the weaker currency and high domestic policy rates will increase interest
high due to payments. Subsequently, the fiscal deficit will decline only marginally to reach 7.7 percent
increasing interest in FY24 and inching down to 7.6 percent in FY25. Gross financing needs will remain
payments sizeable throughout the projection period because of maturing short-term debt (though
short-term deposits are expected to be rolled over), multilateral and bilateral repayments,
and Eurobond maturities. By end-FY24, total public debt, including guaranteed debt, is
projected to decline to 72.4 percent of GDP and further to 70.3 percent by end-FY25.

The path to Under the current policy framework, Pakistan faces sluggish growth and extremely high
economic recovery macroeconomic risks, even assuming effective implementation of the SBA and a stable
requires a decisive political environment. External financing from official creditors and private flows will be
commitment to critical to strengthening the foreign exchange position, stabilizing local currency, and
reforms mitigating inflationary pressures. Gradual and progressive easing of import and capital
restrictions will enable some revival of economic activity. Confidence will remain low
with growth insufficient to support significant poverty reduction, while soft levels of
investment will dampen output as well as future growth potential. A more robust recovery
will require an ambitious medium-term reform agenda backed by strong political
ownership and commitment. This would include reforms to increase revenues (including
from closing exemptions and tapping increased revenue from agriculture, retail, and
property), rationalize expenditures (including through reducing wasteful and regressive
subsidy spending), and restore private sector confidence (including through business
regulatory reform and reforms to state-owned enterprises [SOEs]).

Regaining fiscal and The Special Focus section of this update indicates that sustained fiscal consolidation is
debt sustainability critical to mitigating the rising fiscal and debt sustainability risks. Persistently large budget
can result in a shortfalls have led to the rapid accumulation of public debt, crowding out private
sustained higher investment, and contributing to macroeconomic volatility. The structural fiscal deficit is
growth path an outcome of rigid expenditures, low revenue collections, and macroeconomic and
institutional factors, such as the intergovernmental framework and the fragmentation of
fiscal institutions. These challenges can be addressed through a comprehensive reform of
tax policy, rationalization of public expenditure, and better management of public debt to
lower debt costs and risks. Overall fiscal management will also need to be strengthened
through improved inter-government coordination within the framework of the 18th
Constitutional Amendment and the 7th National Finance Commission (NFC) Award.

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 Restoring Fiscal Sustainability Pakistan Development Update

2. Recent Economic Developments

a. Context
Pakistan faced major Pakistan’s strong post-pandemic recovery came to a halt in FY23. Accumulated economic
economic imbalances, including high fiscal deficits and increasing debt, left Pakistan vulnerable to a
disruptions and series of shocks, including catastrophic floods, increasing world commodity prices, and
uncertainties tight global financing conditions. Repeated delays in implementing the IMF Extended
through FY23 Fund Facility (EFF) program and the associated decline in external financing inflows saw
foreign reserves fall to critically low levels, amid high inflation and sharp depreciation. To
manage these pressures, the authorities introduced exchange rate rigidities, capital flow
restrictions, and import controls. These measures further undermined confidence,
disrupting local supply chains and driving sharp declines in domestic industrial activity,
exports, and remittance flows. Following the expiry of the incomplete EFF program, a
new nine-month SBA was approved by the IMF on July 12, 2023. Under the SBA,
exchange rate flexibility was restored, import controls were eased, and new measures were
introduced to contain the budgeted FY24 deficit. New IMF and bilateral financing drove
some recovery in foreign exchange reserves, but inflation remains high, depreciation has
continued, and confidence remains depressed. Without further fiscal adjustment and
other reforms, the current trajectory remains unsustainable, involving continued low
investment and no significant progress with poverty reduction. Risks are very high. Short-
term stability depends on remaining on track with the SBA, continued fiscal restraint, and
new external financing inflows. Robust economic recovery over the medium term will
require the steadfast implementation of much broader fiscal and economic reforms.

b. Real Sector
Growth
Real GDP is Pakistan’s economy is estimated to have contracted by 0.6 percent y-o-y in FY23, after
estimated to have growing by 6.1 percent in FY22 and 5.8 percent in FY21 (Table 2.1).5 Import volumes
contracted in FY23 declined sharply on the back of import management measures and a weaker currency.
Export volumes also fell but only by around half as much as imports, partly due to
domestic supply chain disruptions and a slowdown in global growth. Similarly, private
investment decreased to a near decade low with business confidence at its lowest level
since the pandemic, amid heightened market uncertainty, tight financing conditions,
difficulties in securing inputs, and a steadily depreciating exchange rate. Simultaneously,
private consumption declined as persistent high inflation, particularly in food and energy
items, impacted households’ real income. Government spending and investment also fell
sharply as high debt servicing costs eroded fiscal space for non-interest current and
development spending.

The 2022 floods The devastating floods in 2022 substantially impacted crops, livestock, grain storage
heavily impacted facilities, and other critical agriculture infrastructure, leading to an estimated agriculture
crop production output growth of just 1.0 percent y-o-y in FY23—substantially below the 4.3 percent rise
in FY22. With about 4.4 million acres of crops damaged, crop output contracted in FY23.
The impact of floods also spilled over into the subsequent Rabi crop season by delaying
the plantation of wheat due to slow dissipation of water from fields. In addition,
difficulties in securing critical inputs, such as fertilizers and tractors due to substantial
price increases, further weighed on agriculture sector growth.6

Import restrictions In line with high borrowing and input costs, import restrictions, and supply chain
and higher disruptions from the floods, industrial sector output contracted by 2.9 percent y-o-y in

5FY23 real GDP growth is based on World Bank staff estimates. The Government’s provisional FY23 GDP growth estimate is 0.3 percent.
6Fertilizer off-take was lower by 15 percent y-o-y during July–March FY23. Source: Ministry of Finance (2023b) Pakistan Economic Survey
FY2022–23. Production and sale of tractors reduced by 46.1 percent and 47.5 percent, respectively. Source: Ministry of Finance (2023a)
Monthly Economic Update & Outlook.

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production costs FY23, after growing by 6.8 percent in FY22. Out of four sub-sectors, outputs of i) mining
weighed down and quarrying, ii) manufacturing, and iii) construction contracted, whereas only the iv)
industrial sector electricity, gas, and water supply sector grew. The Large-Scale Manufacturing (LSM)
activity index, a key indicator for manufacturing activity, contracted by 10.3 percent in FY23
compared to 11.8 percent growth in FY22. Of the 22 sectors in the LSM index, 18 sectors
reported lower production during the year, including textile, food, coke and petroleum
products, chemicals/fertilizers, and pharmaceuticals.

Slower agriculture The slowdown in agriculture and industrial sectors spilled over onto the services sector,
and industrial sector leading to an estimated contraction of 0.5 percent in FY23 from growth of 6.6 percent in
activity also FY22. Sluggish activity in the commodity producing sectors combined with lower imports
weakened the impacted wholesale and retail trade (the largest service sub-sector), leading to an estimated
services sector contraction of 4.5 percent. Similarly, high fuel costs, damaged transport infrastructure due
to the floods, and sluggish agriculture and industrial production is also estimated to have
led to a contraction of 2.9 percent in the transport and storage sector.
Table 2.1: Real GDP Growth
FY18 FY19 FY20 FY21 FY22 FY23e
Real GDP Growth (at factor cost) 6.1 3.1 -0.9 5.8 6.1 -0.6
Agriculture 3.9 0.9 3.9 3.5 4.3 1.0
Industry 9.2 0.2 -5.7 8.2 6.8 -2.9
Services 6.0 5.0 -1.2 5.9 6.6 -0.5
Real GDP Growth (at market price) 6.2 2.5 -1.3 6.5 4.7 -0.6
Private consumption 7.2 5.6 -2.8 9.4 6.7 -1.0
Government consumption 5.5 -1.6 8.5 1.8 -1.3 -7.2
Investment 9.9 -9.7 -6.1 4.0 5.5 -15.4
Gross fixed capital formation 10.3 -11.1 -6.7 3.7 5.7 -17.8
Public 18.5 -33.0 -12.9 11.8 12.1 -15.4
Private 7.1 -1.7 -4.9 1.5 3.8 -18.5
Exports of goods and non-factor services 10.0 13.2 1.5 6.5 5.9 -8.6
Imports of goods and non-factor services 15.7 7.6 -5.1 14.5 11.0 -17.8
Source: Pakistan Bureau of Statistics, World Bank staff calculations.
Notes: e = estimate. FY23 macroeconomic estimates were prepared by World Bank staff and differ from that of the Government. The
Government’s preliminary real GDP (at factor cost) growth estimate for FY23 is 0.3 percent.

Inflation
Inflation reached a Pakistan’s headline consumer price inflation rose from an average of 12.2 percent y-o-y
multi-decade high in in FY22 to a multi-decade high of 29.2 percent in FY23—the highest since FY74. The
FY23 jump was partly due to supply side factors including the floods, higher government
administered energy prices, and a substantially weaker exchange rate. The increase in
inflation was broad-based, with double digit inflation in 10 out of 12 product categories
in the Consumer Price Index (CPI). In addition to supply side factors, the rapid growth
in monetary base also contributed to inflationary pressures (see Box 2.1).

Food inflation rose Food inflation surged in FY23 primarily due to the 2022 catastrophic floods, domestic
sharply, in part due fuel price increases, and currency depreciation. In urban areas, food inflation jumped
to flood-related from 13.4 percent in FY22 to 37.3 percent in FY23, while in rural areas it tripled from
damages 13.0 percent to 40.8 percent during the same period (Figure 2.1 and Figure 2.2). The sharp
increase in food inflation was partly due to the extensive flood-related damages to crops,
livestock, and agriculture infrastructure. Grain storage facilities carrying wheat stocks
were also destroyed, while market uncertainty rose regarding timely plantation of wheat
for the subsequent crop season.7 As reliance on food imports increased amid domestic
shortages, the substantially weaker exchange rate further escalated domestic food prices.8
Furthermore, the high transport and fertilizer costs also increased agriculture producers’
operational costs.

7State Bank of Pakistan (2023d) The State of Pakistan’s Economy.

8In FY23, the quantum of wheat import increased by 23.7 percent y-o-y, soybean oil by 58.4 percent, and pulses by 48.3 percent. Source:
Pakistan Bureau of Statistics. External Trade Statistics.

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Higher energy prices Energy prices rose in rural and urban areas during FY23, partly due to higher taxes on
added further to fuel, the weaker currency, and tariff adjustments in the energy sector.9 Energy inflation
inflationary pressure reached 40 percent in urban areas and 40.1 percent in rural areas during FY23, compared
to 25.5 percent and 24.7 percent, respectively, during FY22. Price hikes in motor fuel
dominated energy inflation, primarily due to cumulative increases in the petroleum
development levy (PDL) from zero at end-June 2022 to PKR 50 per liter by start of
November 2022. Despite global oil prices easing from an average of US$89.2 per barrel
in FY22 to US$84.3 per barrel in FY23, the weaker exchange rate maintained inflationary
pressures in domestic fuel prices. Likewise, the annual rebasing of electricity tariffs and
quarterly tariff adjustment in FY23 led to hikes in electricity prices.10 In parallel, the end-
user gas prices were adjusted by an average of 75 percent in line with amendments in the
pricing structure, including an updated gas tariff slab system, changes in fixed charges,
and the introduction of the category of protected consumers.11

Higher food and Core inflation doubled in rural and urban areas in FY23, reflecting import management
energy inflation measures including higher regulatory duties, the effects of high energy and food inflation
impacted core on wages and prices, and exchange rate depreciation. Urban core inflation rose to an
inflation average of 16.1 percent in FY23 from 8.1 percent in FY22. Similarly, rural core inflation
increased to 20.4 percent in FY23 from 9.0 percent in FY22. Broad-based increases in
production costs and import restrictions through controls on letters of credit and higher
regulatory duties increased prices and constrained the availability of raw material for
industry.12
Figure 2.1: Contribution to Headline Inflation in Urban Figure 2.2: Contribution to Headline Inflation in
Areas Rural Areas
(Percentage points) (Percentage points)
40 45
35 40
30 35
30
25
25
20
20
15
15
10 10
5 5
0 0
Apr-22

Apr-23

Apr-22

Apr-23
Jun-21
Aug-21

Jun-22
Aug-22

Jun-23
Aug-23

Jun-21
Aug-21

Jun-22
Aug-22

Jun-23
Aug-23
Dec-21

Dec-22

Dec-21

Dec-22
Oct-21

Feb-22

Oct-22

Feb-23

Oct-21

Feb-22

Oct-22

Feb-23

Food Energy Core inflation Headline inflation Food Energy Core inflation Headline inflation

Source: Pakistan Bureau of Statistics and World Bank staff Source: Pakistan Bureau of Statistics and World Bank staff
calculations. calculations.

Headline inflation After peaking at 38.0 percent y-o-y in May 2023, monthly headline inflation declined
moderated slightly in steadily for three consecutive months, reaching 27.4 percent in August 2023. This is
June–August 2023 on primarily due to high base effects, despite significant increases in domestic energy prices.
account of base In August 2023, energy inflation fell to 9.4 percent in urban areas and 12.0 percent in
effects rural areas in comparison to 80.7 percent and 67.8 percent in August 2022, respectively.
Food and core inflation also moderated, but to a lesser extent.

9 Energy inflation consists of electricity charges, gas prices, liquified hydrocarbons, solid fuel, and motor fuel.
10 The combined annual rebasing of PKR 7.91/kilowatt hour (kwh) for FY22 and FY23 were implemented in three phases in July 2022 (PKR
3.5/kwh), August 2022 (PKR 3.5/kwh), and October 2022 (PKR 0.91/kwh). The delayed quarterly tariff adjustment (QTA) for Q2–Q4 FY22
was implemented in July 2022 (PKR 1.55/kwh), August 2022 (PKR 0.51/kwh), and October 2022 (PKR 3.21/kwh). Subsequently, the Q1
FY23 QTA was implemented in February 2023 (PKR 1.49/kwh to PKR 4.5/kwh) and the Q2 FY23 QTA was implemented in April 2023
(PKR 0.47/kwh). Source: IMF (2023) Staff Report for Stand-By Arrangement; and National Electric Power Regulatory Authority notifications.
11 IMF (2023) Staff Report for Stand-By Arrangement; and National Electric Power Regulatory Authority notifications.
12 State Bank of Pakistan (2023d) The State of Pakistan’s Economy.

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 Restoring Fiscal Sustainability Pakistan Development Update

Box 2.1: Pressing the Brake and Accelerator at the Same Time!

With loss of access to external capital markets, the Government relied heavily on domestic borrowing to finance the
fiscal deficit in FY23. Government domestic borrowing from commercial banks increased by 76.4 percent in FY23. Banks
increasingly relied on the liquidity injected by the SBP through Open Market Operations (OMOs) to meet the Government’s
growing financing needs. As a result, the size of the SBP’s outstanding OMOs more than doubled in FY23, leading to a 62.2
percent growth in the outstanding aggregate bank borrowing from the SBP (Figure B.2.1).

Financing the fiscal deficit through bank borrowing has led to a rapid growth in monetary base, contributing to
inflationary pressures. In FY23, reserve money and currency in circulation grew by 23 and 21 percent, respectively, exceeding
the growth of the monetary base during COVID-19. As a result, despite weak economic conditions, money supply grew by
14.2 percent, higher than the 13.6 percent growth of money supply in FY22 when real GDP growth expanded by 6.1 percent.
The record high inflation of 29.2 percent in FY23 is therefore partly explained by the rapid growth of the money supply (Figure
B.2.2).

Policy inconsistency has constrained the effectiveness of monetary policy in curbing inflation. The current policy
framework is inconsistent, with attempts to curb inflation through increases in the policy rate partly undermined by the
simultaneous expansion in the monetary base. Higher policy rates are increasing government borrowing costs, driving higher
financing needs. These financing needs are—in turn—being met through increasing borrowing from the domestic banking
system, necessitating increasing liquidity injections through OMOs. Any sudden stop to OMO injections could leave banks
unable to extend further loans to the Government. The only sustainable solution is therefore to reduce the Government’s
primary deficit, reducing financing needs and borrowing from the domestic banking sector, and thereby alleviating the
requirement for new liquidity injections.

Figure B.2.1: Stock of Outstanding OMOs Figure B.2.2: Monetary Base and Inflation
8500 12,000 40.0
8000
7500 11,000 35.0
7000
6500 30.0
6000 10,000
PKR billion

5500 25.0

Percent
PKR billion

5000 9,000
4500 20.0
4000
3500 8,000
15.0
3000
2500 7,000
2000 10.0
1500
1000 6,000 5.0
Nov-21
Jan-21

Sep-21

Jan-22

Sep-22
Nov-22
Jan-23
Jul-21

Jul-22
May-21

May-22

May-23
Mar-21

Mar-22

Mar-23
500
0
Sep-19

Sep-20

Sep-21

Sep-22
Dec-20

Dec-21
Dec-19

Dec-22
Mar-20

Mar-21

Mar-22

Mar-23
Jun-19

Jun-20

Jun-21

Jun-22

Jun-23

Monetary base Headline inflation (rhs)

Source: State Bank of Pakistan. Source: State Bank of Pakistan monetary survey.

Poverty
Poverty is estimated The poverty headcount using the global lower-middle-income poverty line (US$3.65/day
to have increased in 2017 purchasing power parity [PPP] per capita) is projected to reach 39.4 percent in
FY23 due to record FY23—more than 5 percentage points higher than in FY22 (see Annex 2.1 for projection
high food inflation, methodology).13 The significant increase in poverty is due to reduced economic activity
weak labor markets, and incomes, record high food and energy prices, and disruption to services and loss of
and devastating crops and livestock during the catastrophic 2022 floods. More than 80 percent of poor
floods workers rely on agriculture, manufacturing, construction, and trade sectors for
employment.14 Muted economic activity in these sectors has had negative impacts on job
quality and labor incomes for poor households and for those at risk of falling into poverty.
The real value of remittances from abroad has also fallen. At the same time, food inflation
nearly tripled, reaching an average of 38.7 percent in FY23. As a result, households’ real
incomes and purchasing power declined. This is particularly true for poor and vulnerable
households, which spend roughly half their budgets on food, with households in the
poorest decile experiencing a 7-percentage point higher inflation rate than the richest
decile.

13 World Bank staff estimates. The last Household Integrated Economic Survey (HIES) which allowed accurate measurement of poverty took
place in 2018. A new survey is needed to update the poverty headcount.
14 World Bank staff calculations based on the HIES 2018–19.

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 Restoring Fiscal Sustainability Pakistan Development Update

Expansion of In an effort to assist households at the lower end of the income distribution facing these
targeted cash challenging conditions, the Government expanded the flagship social protection
transfers was sought program, the Benazir Income Support Programme (BISP). The number of beneficiary
to mitigate the households increased from 7.7 million in FY22 to 9.0 million in FY23 (as of March
negative welfare 2023),15 and the BISP cash transfer amount was increased by 25 percent with effect from
shocks experienced January 2023.16 Other pro-poor initiatives included a one-time targeted fuel subsidy—the
by the poor Sasta Petrol/Sasta Diesel Scheme—introduced in June 2022, and a cash relief package
rolled out in flood-affected districts in August 2022.17 While these efforts are likely to
have supported many low-income households, they were short term in nature. Overall,
these increased transfers were not sufficient to compensate for the significant increase in
food and energy prices.

c. Monetary and Financial Sector

Monetary

In response to With rising inflationary pressures, the SBP continued to hike the policy rate throughout
persistent inflation, FY23, a trend that started in the second half of 2021. Since July 2022, the SBP has
the SBP continued to increased the policy rate by a cumulative 825 bps to reach 22.0 percent by end-FY23.
hike interest rates Additionally, the gap between the policy rate and the interest rate on two concessionary
financing facilities—Export Finance Scheme and Long-Term Financing Facility—was
reduced from 500 bps to 300 bps to strengthen monetary policy transmission.18 However,
the real interest rate remained negative with inflation averaging 29.2 percent in FY23.
Given the persistent inflationary pressures and slight uptick in inflation expectations,19
monetary policy is expected to remain tight in the near term.

Financial Sector

Private sector In June 2023, bank credit to the public sector was 73.7 percent of the total credit
borrowing remained extended. Credit to the private sector paled in comparison, standing at 26.2 percent and
low and concentrated declining from 30.3 percent of total bank credit in June 2022.20 The private sector’s access
as bank lending to to credit continued to shrink in FY23 due to the Government’s increasing reliance on
the public sector financing from commercial banks amid limited external financing inflows. Additionally,
grew significantly the private sector’s demand for credit was also low due to the high cost of borrowing and
general economic slowdown. Within the limited private sector borrowing, bank credit
was largely concentrated in the manufacturing sector, which constituted 56 percent of
total loans to the private sector in June 2023, and more than 18 percent of private sector
credit was through SBP development finance schemes. Bank lending to small and
medium enterprises (SMEs) had also steadily fallen to 5.3 percent of total domestic
private sector credit in March 2023, the lowest in over a decade. This is partly due to
deterioration in the asset quality of banks’ SME portfolios.

Banks’ capital While banks’ profitability is increasing in the context of rising interest rates, underlying
buffers have eroded risks are increasing. The deepening sovereign–bank nexus, continuing macroeconomic
and mask significant instability, and deteriorating asset quality continue to negatively impact banks’ capital
risks to the sector position. The aggregate commercial banks’ CAR stood at 16.3 percent in March 2023,
dropping from 17 percent in December 2022. While this is still well above the minimum
regulatory requirement (11.5 percent), several smaller banks remain undercapitalized.

15 Ministry of Finance (2023b) Pakistan Economic Survey FY2022–23.

16 BISP (2023) Press Release.
17 The fuel subsidy involved an additional cash transfer of PKR 2,000, disbursed to existing and new BISP beneficiaries that were made

eligible by relaxing the Proxy Means Testing score cut-off. Under the flood relief program, immediate cash relief of PKR 25,000 per family
was offered in flood-affected regions notified by National Disaster Management Authority.
18 State Bank of Pakistan (2022b) Circular No. 13.
19 State Bank of Pakistan (2023a) Consumer Confidence Survey.
20 State Bank of Pakistan (2023b) “Credits/Loans Classified by Borrowers.”

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 Restoring Fiscal Sustainability Pakistan Development Update

Additionally, the CAR does not adequately reflect the risks of banks’ exposure to the
Government, which receives a zero-risk weight. The economic slowdown is further
impacting the asset quality of banks. The ratio of non-performing loans (NPLs) to total
lending has increased marginally to 7.8 percent in March 2023 from 7.5 percent in June
2022. While 90.7 percent of NPLs are provisioned for, risks are fast emerging, with many
banks showing an accelerated rise in NPLs.21

d. External Sector
Pakistan’s external Despite narrowing of the CAD, Pakistan’s external position weakened significantly in
position weakened in FY23, reflecting low international financial inflows and sizable external debt servicing
FY23 payments. The drop in imports was in large part due to import management measures
aimed at preserving scarce international reserves. Exports also fell due to unavailability of
imported inputs and slow global growth. Meanwhile, remittances were partly diverted
towards informal channels due to exchange rate rigidities introduced by the Government.
Amid high debt repayments, the financial account saw a deficit for the first time in nearly
20 years. The broader loss of confidence due to the Government’s distortive policies on
imports, the exchange rate, and capital repatriation further discouraged fresh
disbursement and investment inflows. The resulting large balance of payments deficit led
to a significant decrease in international reserves in FY23. In line with the mounting
external pressures and loss of confidence, the Rupee depreciated sharply against the major
global currencies.
Figure 2.3: Annual Current Account Balances Figure 2.4: Annual Trade Balances
(US$ billion) (US$ billion)
40 40

20 20
-4.4 -2.8 -2.4
0 -13.4
0
-19.2 -17.5
-24.4 -24.8
-20 -20 -32.6 -31.2
-37.3
-44.9
-40 -40

-60
-60
FY18 FY19 FY20 FY21 FY22 FY23
-80
Secondary Income Balance
Primary Income Balance FY18 FY19 FY20 FY21 FY22 FY23
Services Trade Balance
Goods Trade Balance Imports Exports Trade Balance
Current Account Balance
Source: State Bank of Pakistan and World Bank staff calculations. Source: State Bank of Pakistan and World Bank staff calculations.
Note: A positive financial account balance represents inflows.

The CAD narrowed The CAD decreased from US$17.5 billion (4.7 percent of GDP) in FY22 to US$2.4 billion
to a 10-year low in (0.7 percent of GDP) in FY23, the narrowest since FY13 (Figure 2.3 and Table 2.2). The
FY23 smaller CAD was largely due to a contraction of 28.9 percent in imports of goods and
services, reflecting the impact of administrative measures, lower global commodity prices,
a depreciated currency, and reduced domestic economic activity. Meanwhile, exports also
fell by 11.1 percent on account of lower agriculture output due to the floods, shortage of
inputs from import controls,22 and slower global growth. As a result, the total trade deficit
narrowed by 44.7 percent from US$44.9 billion in FY22 to US$24.8 billion in FY23
(Figure 2.4).

21 State Bank of Pakistan (2023c) Statistics of the Banking System.

22 State Bank of Pakistan (2023d) The State of Pakistan’s Economy.

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 Restoring Fiscal Sustainability Pakistan Development Update

Table 2.2: Balance of Payments Summary1

(US$ million unless mentioned otherwise)
Percent Percent
FY19 FY20 FY21 FY22 FY23 of GDP of GDP
in FY22 in FY23
i. Current Account (A+B+C+D) -13,434 -4,449 -2,820 -17,481 -2,387 -4.7 -0.7
A. Good trade balance -27,612 -21,109 -28,634 -39,050 -24,076 -10.4 -7.2
Goods exports 24,257 22,536 25,639 32,493 27,903 8.7 8.3
Goods imports 51,869 43,645 54,273 71,543 51,979 19.1 15.5
B. Services trade balance -4,970 -3,316 -2,516 -5,840 -761 -1.6 -0.2
Services exports 5,966 5,437 5,945 7,102 7,302 1.9 2.2
Services imports 10,936 8,753 8,461 12,942 8,063 3.5 2.4
C. Balance on primary income2 -5,610 -5,459 -4,400 -5,248 -5,732 -1.4 -1.7
D. Balance on secondary income2 24,758 25,435 32,730 32,657 28,182 8.7 8.4
of which remittances 21,740 23,131 29,450 31,279 27,027 8.3 8.1
ii. Capital Account 229 285 224 205 374 0.1 0.1
1. Balance from current and capital
-13,205 -4,164 -2,596 -17,276 -2,013 -4.6 -0.6
accounts (i+ii)3
2. Financial accounts4 -11,759 -9,313 -8,768 -11,261 1,781 -3.0 0.5
of which:
Direct investment -1,436 -2,652 -1,648 -1,702 -316 -0.5 -0.1
Portfolio investment 1,274 409 -2,774 55 1,012 0.0 0.3
3. Errors and omissions -58 150 -619 -303 -425 -0.1 -0.1
Overall balance (-1+2-3) 1,504 -5,299 -5,553 6,318 4,219 1.7 1.3
Gross SBP reserves5 9,301 13,724 18,716 11,090 5,669
Memorandum items
GDP (US$, million) 321,834 300,832 348,933 374,697 334,458
Export growth (percent, y-o-y) -1.3 -7.4 12.9 25.4 -11.1
Import growth (percent, y-o-y) -7.6 -16.6 19.7 34.7 -28.9
Remittance growth (percent, y-o-y) 9.2 6.4 27.3 6.2 -13.6
Source: State Bank of Pakistan and World Bank staff calculations
Notes:
1 As per Balance of Payments Manual 6 (BPM6).
2 In BPM6, the income account has been renamed “primary income” and current transfers, “secondary income.”
3 A negative balance shows that the economy is a net borrower from the rest of the world.
4 A negative balance highlights a net increase in the incurrence of foreign liabilities.
5 Includes Cash Reserve Requirement and Special Cash Reserve Requirement.

Higher interest The income account surplus narrowed due to reduced remittance inflows and higher
payments and lower interest payments on government external debt. The income account surplus shrank to
remittance inflows US$22.5 billion in FY23 from US$27.4 billion in FY22, with a 9.2 percent y-o-y increase
weighed on the in the primary income deficit and a 13.7 percent decline in the secondary income surplus.
income account The primary income deficit widened on rising interest payments on external debt, partly
balance due to tightening global financial conditions. Under secondary income, worker
remittances fell by 13.6 percent from a record high of US$31.3 billion in FY22 to US$27.0
billion in FY23. The economic slowdown in the high-income host countries contributed
to the decline in remittances, combined with the large and varying spread between open
market and official rate, incentivizing the use of informal channels.

The financial The financial account swung to a deficit for the first time since FY04 as amortization
account recorded a payments and capital outflows surpassed international inflows. Net external financial
deficit reflecting outflows amounted to US$1.8 billion in FY23, compared to net inflows of US$11.3 billion
large amortization in FY22.23 Pakistan faced rising debt distress resulting in credit rating downgrades and
payments loss of investor confidence, which were further compounded by the Government’s

23 The FY23 financial account reflects repayment of US$5.2 billion in commercial loans, US$1.0 billion maturing international bond
repayments, and repayment of multilateral and bilateral debts.

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 Restoring Fiscal Sustainability Pakistan Development Update

policies that discouraged private investment and capital flows.24 Net foreign direct
investment (FDI) fell to US$0.3 billion in FY23, with FDI declining in most of the sectors
including power, financial, telecom, and trade sectors.25 Net portfolio investment saw
outflows of US$1.0 billion in FY23, reflecting the maturing Sukuk bond repayment.

The overall balance Despite the narrow CAD, the balance of payments registered an overall deficit of US$4.2
remained negative billion (1.3 percent of GDP) in FY23 compared to a deficit of US$6.3 billion (1.7 percent
resulting in a of GDP) in FY22. As a result, the SBP’s gross reserves, including the Cash Reserve
reduction of Requirement and cash holdings, fell to a new low of US$5.7 billion, equivalent to only
international reserves one month of imports at end-June 2023,26 the lowest in the last two decades. The Rupee
depreciated by 28.6 percent against the US dollar over FY23, with a 9 percent depreciation
in real exchange rate.

In July 2023, the After four months of consecutive current account surpluses during March–June 2023,
current account the current account turned to a deficit in July 2023 as import restrictions were partially
registered a deficit relaxed. In line with the CAD, the trade deficit—which had been declining for four
consecutive months—increased again in July as imports grew by around 30 percent
month-on-month whereas exports remained stable. However, the CAD remained lower
y-o-y than in July FY22, due to a smaller trade deficit.

e. Fiscal and Debt Sustainability

Pakistan’s large Despite a lower primary deficit, Pakistan’s overall fiscal deficit remained broadly
fiscal deficits persist unchanged in FY23 due to an increase in interest payments. The consolidated fiscal deficit
due to high interest fell marginally to 7.8 percent of the GDP in FY23 from 7.9 percent in FY22 (Figure 2.5
payments and Table 2.3).27 The rise in domestic and international interest rates and the depreciation
of the Rupee resulted in debt servicing costs consuming almost one-third of tax revenues.
Nevertheless, the Government’s efforts to lower subsidies and grants combined with
higher revenue from direct taxes and the PDL led to a substantially lower primary deficit
of 0.8 percent of GDP in FY23 compared to 3.1 percent in FY22. However, the revenue
balance, which measures the overall revenues’ capacity to finance current expenditures,
deteriorated in FY23 compared to the previous year due to substantial growth in interest
payments (Figure 2.6).

Overall revenues Total revenue fell to 11.6 percent of GDP in FY23 from 12.1 percent of GDP in FY22
declined with lower with both tax and non-tax revenue declining by 0.2 percentage points. Within tax revenue,
revenue from revenue from indirect taxes—including sales tax on goods and services, custom duties,
indirect taxes and excise duties—fell to 5.2 percent of GDP in FY23 from 6.3 percent of GDP in FY22.
This was largely due to a decline in imports, which lowered revenue from sales tax and
custom duties on imported goods. Conversely, revenue from direct taxes and the PDL
rose during the year. The hike in the PDL from zero to PKR 50 per liter increased PDL
revenues to PKR 580 billion, almost 4.5 times higher than in FY22.28 In addition, revenue
from direct taxes grew in part due to changes in tax policy measures, including revisions
in income tax rates, super tax on banks and non-bank firms, and higher property taxes.29
Non-tax revenue declined on account of lower profits of the SBP and the Pakistan
Telecommunication Authority.

24 For instance, the foreign currency control measures decreased repatriated profits and dividends on foreign investment to US$331 million
in FY23 from US$1,680 million in FY22. Source: State Bank of Pakistan.
25 There were also FDI outflows in the form of disinvestment from the mining sector. Source: State Bank of Pakistan (2023d) The State of

Pakistan’s Economy.
26 Based on World Bank staff projections for next 12 months of imports.
27 In this section, FY23 fiscal outcomes are reported as share of World Bank estimated GDP for FY23.
28 After remaining at zero between mid-March 2022 to June 2022, the PDL was increased to PKR 10 per liter at the start of July 2022 and

gradually hiked to PKR 60 per liter between July 2022 and September 2023. The Government now considers tax on petroleum products as
part of non-tax revenue; however, for consistency against historical years these are included in tax revenue.
29 Revenue mobilization measures introduced in the Finance (Supplementary) Act 2022 and Finance Act 2022 include revisions in income

tax rates, imposition of super tax on high-earning persons, and measures to widen the tax base—for example tax on deemed rental income
from property and removal of domestic General Sales Tax (GST) exemptions helped increase tax revenue. Further, increase in government
salaries also cushioned tax collections and rising interest rates pushed up returns on government securities, saving deposits, saving certificates,
banks’ profitability, and income taxes. Source: State Bank of Pakistan (2023d) The State of Pakistan’s Economy.

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 Restoring Fiscal Sustainability Pakistan Development Update

Figure 2.5: Consolidated Fiscal Balance (excluding Figure 2.6: Primary and Revenue Balance (excluding
grants) grants)
(PKR billion and percent of GDP) (PKR billion and percent of GDP)
0 0.0 0 0.0
-1,000 -1.0 -1,000
-2.0 -2.0

Percent of GDP
-2,000 -2,000

Percent of GDP

PKR billion
-3.0
PKR billion

-3,000 -4.0 -3,000 -4.0

-4,000 -5.0 -4,000
-6.0 -6.0
-5,000 -5,000
-7.0
-6,000 -8.0 -6,000 -8.0
FY18 FY19 FY20 FY21 FY22 FY23
-7,000 -9.0
FY18 FY19 FY20 FY21 FY22 FY23 Primary balance (PKR billion)
Revenue balance (PKR billion)
Fiscal balance (PKR billion) Primary balance as percent of GDP (RHS)
Fiscal balance as percent of GDP (RHS) Revenue balance as percent of GDP (RHS)
Source: Ministry of Finance and World Bank staff calculations. Source: Ministry of Finance and World Bank staff calculations.
RHS: Right hand side Note: Revenue balance is the difference between current expenditure
and revenue. RHS: Right hand side

Interest payments Total expenditure decreased to 19.4 percent of GDP in FY23 from 20 percent in FY22,
rose substantially as the decline in development spending was partially offset by the increase in current
due to expenditure. The large interest payments, reaching 7.0 percent of GDP in FY23, were the
macroeconomic main driver of increased current expenditure, which rose to 17.5 percent of GDP in FY23
shocks from 17.3 percent in FY22. On external debt, interest payments more than doubled due
to the Rupee’s weakening against major currencies. At the same time, increases in the SBP
policy rate saw interest payments on domestic debt grow by 79.3 percent in FY23, with
68 percent of the domestic debt stock consisting of floating rate instruments at the end
of December 2022.30

Non-interest current Non-interest current expenditure fell to 10.5 percent of GDP in FY23, from 12.5 percent
expenditure fell in of GDP in FY22. The decline was largely due to lower spending on subsidies and grants.
line with fiscal Subsidies fell as the Government curtailed spending on power sector subsidies and
consolidation efforts reversed last year’s subsidy on electricity and petroleum prices. Similarly, grants declined
with lower spending on COVID-19-related programs, railways, contingent liabilities, and
the Higher Education Commission. This created some fiscal space for the Government
to provide subsidized electricity and re-gasified liquefied natural gas for selected export-
oriented industries and increase spending under BISP in the wake of the 2022 floods.

Development Development expenditure and net lending fell to 2.4 percent of GDP in FY23 from 2.5
expenditure also percent in FY22 largely due to a drop in provincial development spending. In comparison,
declined on account the spending under the federal Public Sector Development Programme (PSDP) rose with
of lower provincial higher spending on infrastructure projects, including the construction of roads, dams, and
spending bridges, as well as programs for social and regional development.

Fiscal deficit was The Government relied predominantly on domestic sources to finance the fiscal deficit
financed primarily as external repayments exceeded inflows. With the net external inflows turning negative,
from domestic financing from domestic sources rose by 76.4 percent. Out of total domestic financing,
sources bank financing constituted 49 percent and remained stable in level terms. However,
financing from non-bank institutions rose three-fold, making up 51 percent of domestic
financing.31 Historically, non-bank institutions have held around 20 percent of annual
domestic financing.

30Ministry of Finance (2023c) Public Debt Bulletin.

31Non-bank financing consists of mutual funds, insurance companies, non-bank financial institutions, and the Employees’ Old-Age Benefits
Institution.

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 Restoring Fiscal Sustainability Pakistan Development Update

Public debt remains By the end of FY23, total public and publicly guaranteed debt had reached PKR 68.4
elevated with high trillion (82.3 percent of estimated GDP), increasing from PKR 53.7 trillion (80.7 percent
liquidity risks of GDP) at the end of FY22. Of the total public debt, the share of external debt was 40.9
percent whereas short-term debt was 13.7 percent. Liquidity risks remain high amid
sizeable external financing needs and low foreign reserves. Large revaluation losses due
to the weakening of the domestic currency and an increase in gross financing needs with
large amortization payments contributed to the rise in public debt. In addition, new debt
was largely sourced through long-term domestic debt instruments carrying floating
interest rates, which improved the overall maturity profile but also increased debt
servicing costs and interest rate risks.
Table 2.3: Summary of Fiscal Operations
(PKR billion unless mentioned otherwise)
Percent Percent
FY19 FY20 FY21 FY22 FY23 of GDP of GDP
in FY22 in FY23
Total Revenue 4,901 6,272 6,903 8,035 9,634 12.1 11.6
Tax revenue1 4,477 4,751 5,760 6,947 8,441 10.4 10.2
Federal 4,075 4,337 5,251 6,335 7,791 9.5 9.4
Provincial 402 414 508 612 650 0.9 0.8
Non-tax revenue 424 1,521 1,144 1,088 1,193 1.6 1.4
Total Expenditure 8,346 9,648 10,307 13,295 16,155 20.0 19.4
Current expenditure 7,104 1,813 9,084 11,521 14,583 17.3 17.5
of which:
Interest payments 2,091 742 2,750 3,182 5,831 4.8 7.0
Defense 1,147 1,213 1,316 1,412 1,586 2.1 1.9
Subsidies2 - - 425 1,530 1,080 2.3 1.3
Development expenditure and net
lending 1,219 1,204 1,316 1,657 1,953 2.5 2.4
of which:
PSDP 1,008 1,090 1,211 1,617 1,893 2.4 2.3
Statistical discrepancy 22 -87 -93 116 -381 0.2 -0.5
Fiscal Balance (excl. grants) -3,445 -3,376 -3,403 -5,260 -6,521 -7.9 -7.8
Primary Balance (excl. grants) -1,354 -2,634 -654 -2,077 -690 -3.1 -0.8
Public Debt (including guaranteed debt) 35,569 39,949 43,349 53,745 68,421 80.7 82.3
External debt 12,869 14,323 14,676 19,677 26,092 29.5 31.4
Domestic debt 20,732 23,283 26,265 31,085 38,809 46.7 46.7
Guaranteed debt 1,969 2344 2407 2983 3520 4.5 4.2
Memorandum items
GDP (PKR billion) 43,798 47,540 55,836 66,624 83,097
Source: Ministry of Finance and World Bank staff calculations.
Notes:
1 From FY21 onwards, the Ministry of Finance has included revenue from Gas Infrastructure Development Cess, natural gas development

surcharge, and petroleum levy in non-tax revenue. For consistency of analysis across years, these taxes have been included in tax revenue.
2 Prior to FY21, subsidies data was not reported in the fiscal operations data published by the Ministry of Finance.

f. Medium-Term Outlook
Limited by external Under a baseline scenario, political conditions will remain stable and the fiscal deficit will
sector constraints, be effectively contained, including through limited new expenditure and revenue
GDP growth is measures. With little progress against structural reforms, however, confidence will remain
projected to remain low, growth sluggish, and risks exceptionally high. Even with the completion of the IMF-
below potential in SBA, associated bilateral financing inflows, and continued rollovers, reserves are
the medium term projected to remain low, averaging less than one month of total imports over FY24–25.
Given the large amortization payments and limited private inflows, the Government will
be forced to maintain import controls, constraining the viable pace of economic recovery.

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 Restoring Fiscal Sustainability Pakistan Development Update

Real GDP growth is therefore expected to recover only marginally to 1.7 percent in FY24
(Table 2.4). Low investment and continued import controls will constrain real GDP
growth below potential in the medium term, reaching only 2.4 percent in FY25.

Recovery in crop Recovery from the 2022 floods is expected to see 2.2 percent agriculture growth in FY24,
production and partly supported by the higher estimated output of major crops, including cotton and rice.
industrial sector will Agriculture sector growth is projected to further strengthen to 2.4 percent in FY25 as
support economic inflationary pressures and supply chain challenges gradually dissipate. Phased and gradual
growth over FY24–25 easing of import restrictions will also support industrial sector activity over the medium
term, with sectoral growth increasing to 1.4 percent in FY24 and further to 2.3 percent in
FY25. Together, the improvements in the agriculture and industrial sectors will spill over
to the services sector, led by recovery in the largest sub-sectors of wholesale and retail
trade, and transport and storage. Collectively, services sector activity is expected to remain
muted but grow marginally at 1.5 percent in FY24 and 2.4 percent in FY25.

External financing The CAD is forecasted to widen to 1.4 percent of GDP in FY24 and further to 1.5 percent
pressures will remain in FY25, with a widening trade deficit and weak remittance inflows. With the IMF-SBA
high, leading to only financing and associated new bilateral inflows from regional partners,32 import controls
marginal increase in will be gradually eased. Total import values are therefore expected to increase by 8.5
CAD percent in FY24. With the greater availability of imported critical inputs for export-
oriented sectors and higher expected crop production, particularly of rice, total export
value is forecast to grow by 6.0 percent in FY24. With imports projected to grow faster
than exports, the trade deficit is expected to widen. Meanwhile, worker remittances are
expected to decline due to slower growth in host countries. Pakistan’s external financing
needs will remain high in the medium term, exerting pressure on foreign exchange
reserves and making the complete removal of all import restrictions unlikely over FY24–
25.

Inflationary Consumer price inflation is projected to moderate to 26.5 percent in FY24 and to 17.0
pressures will remain percent in FY25. Inflation will moderate due to high base effects and the gradual
elevated dissipation of domestic supply chain disruptions, despite the weak currency and upward
adjustments to administered domestic energy prices.

Resumption of Poverty reduction is projected to be gradual in the medium term, owing to weak growth
growth will support and lower labor income, persistent inflation (especially for food and energy), and lower
gradual decline in remittances. The poverty headcount rate, measured at the lower-middle-income country
poverty poverty line of US$3.65/day 2017 PPP, is expected to decline to 37.2 percent in FY24
and further to 35 percent in FY25 on resumption of growth and economic activity.
However, the higher energy prices will maintain domestic price pressures and may
contribute to growing social and economic insecurity. Protracted and elevated food and
energy price inflation, in the absence of substantial growth, could cause social dislocation
and have negative welfare impacts, especially on the worse-off households with already
depleted savings and reduced incomes. Increased targeted transfers will play a vital role
to protect the poorest from these risks.

Fiscal consolidation Revenues are expected to recover to 11.9 percent of GDP in FY24 and rise further to
will remain critical 12.3 percent of GDP in FY25 due to the resumption of economic growth and expansion
due to high liquidity in imports. Non-tax revenues are also expected to increase on account of temporary
risks higher profits from the SBP. However, expenditure pressures will remain high due to
large interest payments on the back of the depreciated exchange rate, tight global
financing conditions, and the high domestic policy rate. Total expenditures are expected
to reach 19.6 percent of GDP in FY24 and increase further to 19.8 percent in FY25. As
a result, the overall fiscal deficit (excluding grants) is expected to narrow marginally to 7.7
percent of GDP in FY24 and further decline to 7.6 percent of GDP in FY25. Given the
persistent fiscal pressures, the Government is expected to rationalize non-interest
expenditure and the primary deficit is projected to narrow to 0.4 percent of GDP in FY24
and further to 0.3 percent of GDP in FY25. Gross financing needs will remain sizeable

32 SBP gross reserves increased

to US$9.0 billion (equivalent to 1.6 months of imports) at end-August 2023, up from US$5.7 billion (equivalent
to one month of imports) at end-June 2023. The higher level of foreign reserves has enabled the gradual easing of import restrictions.

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 Restoring Fiscal Sustainability Pakistan Development Update

throughout the projection period because of maturing short-term debt (though short-
term deposits are expected to be rolled over), multilateral (including IMF) and bilateral
repayments, and Eurobond maturities. Public debt, including guaranteed debt, is expected
to reach 72.4 percent of GDP in FY24 and decline further to 70.3 percent of GDP in
FY25.
Table 2.4: Pakistan Macroeconomic Outlook (FY20–25)
(Annual percent change unless indicated otherwise)
2019/20 2020/21 2021/22 2022/23e 2023/24f 2024/25f
Real GDP Growth, at constant factor
-0.9 5.8 6.1 -0.6 1.7 2.4
prices1
Agriculture 3.9 3.5 4.3 1.0 2.2 2.4
Industry -5.7 8.2 6.8 -2.9 1.4 2.3
Services -1.2 5.9 6.6 -0.5 1.5 2.4
Real GDP Growth, at constant market
prices -1.3 6.5 4.7 -0.6 1.7 2.4
Private consumption -2.8 9.4 6.7 -1.0 1.9 2.6
Government consumption 8.5 1.8 -1.3 -7.2 1.9 2.8
Gross fixed capital formation -6.7 3.7 5.7 -17.8 0.8 2.2
Exports, goods, and services 1.5 6.5 5.9 -8.6 0.7 2.0
Imports, goods, and services -5.1 14.5 11.0 -17.8 1.7 3.2
Inflation (CPI) 10.7 8.9 12.2 29.2 26.5 17.0
Current Account Balance (% of GDP) -1.5 -0.8 -4.7 -0.7 -1.4 -1.5
Financial and Capital Account Balance,
3.2 2.6 3.1 -0.4 1.9 1.8
(% of GDP)
Fiscal Balance (excluding grants, % of
-7.1 -6.1 -7.9 -7.8 -7.7 -7.6
GDP)
Debt (% of GDP) 84.0 77.6 80.7 82.3 72.4 70.3
Primary Balance (excluding grants, % of
-1.6 -1.2 -3.1 -0.8 -0.4 -0.3
GDP)
Sources: Pakistan Bureau of Statistics, State Bank of Pakistan, and World Bank staff estimates.
Notes: e=estimate; f=forecast.
1 The Government’s provisional estimates for real GDP growth at factor prices in FY23 is 0.3 percent. World Bank estimates differ from the
Government’s.

g. Risks and Priorities

Liquidity risks are Pakistan has sizeable upcoming domestic and external payments for the remainder of
extremely high with FY24. With limited fiscal space and foreign reserves amounting to only US$9.0 billion at
low foreign reserves end-August 2023, the country faces substantial liquidity risks. Capacity to meet the high
and large external gross and external financing needs depends heavily on achieving necessary fiscal
payments consolidation, the materialization of expected rollovers and refinancing of regional
bilateral deposits and commercial loans, and remaining on track with the IMF-SBA
program.

Political and social Political and social pressures during the run-up to elections may impact implementation
risks are high due to of required fiscal consolidation, including pressures for energy price relief through new
the upcoming subsidies. Weak investment confidence partly reflects continuing uncertainties regarding
elections the election timing and process, with most investors citing political instability as the
primary constraint to investment in Pakistan.

External factors pose Tighter global financing conditions, potential increases in world energy and food prices,
further risks to and slower global growth pose additional risks for the macroeconomic outlook. Global
macroeconomic inflationary pressures, though moderating gradually with weaker demand, are at risk of
stability remaining elevated amid the extension of production cuts by oil producing countries,
export bans on food items by large global exporters, and the continued war in Ukraine
impacting fertilizer, wheat, and corn prices.33 Subdued global demand, tighter financing

33i) In August 2023, Saudi Arabia announced the extension of production cuts of 1 million barrels per day for another month; ii) amid
continued bombing of Ukrainian ports and grain silos, the Russian Federation announced on July 17, 2023 that it would not renew the United
Nations-brokered deal enabling Ukrainian grain and oilseed shipments; and iii) in July, India (which accounts for 40 percent of global rice
exports) announced an export ban on non-basmati rice. Source: World Bank (2023a). Global Economic Prospects.

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 Restoring Fiscal Sustainability Pakistan Development Update

conditions and persistent inflationary pressures will weigh on Pakistan’s economic growth
and current account balance, which will in turn affect the country’s ability to meet its
external financing requirements.

Structural reforms The current macroeconomic outlook represents slow growth, marginal progress with
remain critical to poverty reduction, continued erosion of living standards, and extremely high external
improve confidence risks. Continued weak domestic and foreign investment will undercut future growth
and boost potential. A more robust economic recovery will require the steadfast implementation of
investment a broad reform program, including: i) reduction of protectionist trade policies to increase
competitiveness and exports; ii) reduction of distortive subsidies, especially in agriculture
and energy sectors; iii) drastic reduction of tax exemptions and expansion of the tax base
to increase progressive taxation of agriculture income, property, and retail; iv) measures
to cut red tape and ease the business environment; v) improving the financial viability of
the power sector by lowering generation costs, raising cost recovery, and reducing
inefficiency and losses in distribution; vi) broader measures to introduce private
participation in the SOE sector, including through selective privatization of SOEs
operating in sectors open to competition; and vii) reforms and increased public
investments to improve human development outcomes, including addressing child
stunting and poor educational outcomes. These reforms need to be complemented by a
coherent fiscal and monetary policy mix and market determined exchange rate. Critical
priorities for fiscal reform are outlined in the Special Focus section.

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 Restoring Fiscal Sustainability Pakistan Development Update

3. Restoring Fiscal Sustainability

a. Introduction
Pakistan’s fiscal Fiscal issues are at the heart of many of Pakistan’s current economic challenges. Pakistan’s
policies pose risks to large and persistent fiscal deficits have led to public debt accumulation, crowding out
macroeconomic private sector borrowing and posing macroeconomic risks. The tax structure is
sustainability and distortionary and inequitable, providing insufficient resources to pay for critical
long-term growth government services, while contributing to the misallocation of resources within the
economy. Because public expenditures are rigid and focused on consumption rather than
investment, government spending drives inflation and imports, rather than expanding the
productive base of the economy. Periods of high spending therefore necessitate
subsequent remedial cooling policy measures to resolve the resulting fiscal and external
imbalances, creating recurrent boom–bust cycles that deter investment and slow
economic growth.

Institutional Pakistan’s existing fiscal institutions and intergovernmental coordination arrangements

challenges are constraining effective management of the Government’s finances and contributing to
exacerbate risks the fiscal sustainability challenge. Fiscal policy making is fragmented across numerous
bodies, resulting in institutional gaps that contribute to the lack of focus on achieving
sustainable fiscal outcomes at the national level. In parallel, current approaches to debt
management, partly arising from the weaknesses of debt management institutions, have
led to higher debt risks and costs.

This Special Focus This Special Focus topic highlights weaknesses in current fiscal policies and institutional
provides a roadmap arrangements and presents a reform roadmap to address these challenges. The remainder
to restore fiscal of this Special Focus is divided into Six Sections. Section b briefly covers stylized facts
sustainability about Pakistan’s fiscal deficits and debt accumulation. Section c provides an overview of
the key challenges in domestic revenue mobilization and analyzes avenues through which
revenues can be enhanced. Section d analyzes the structure of public expenditures and
explores options for expenditure rationalization. Section e discusses the financing of
fiscal deficits and Pakistan’s public debt issues. Section f describes Pakistan’s architecture
of fiscal federalism and its implication for fiscal outcomes. Finally, Section g presents a
detailed roadmap of recommendations based on the preceding analysis.

b. Pakistan’s Fiscal Deficits and Debt Accumulation

Pakistan’s fiscal Fiscal deficits in Pakistan have been persistently large. In FY23, the general government
deficits have been fiscal deficit stood at 7.8 percent of GDP, just marginally lower than the 22-year high
large and are deficit of 7.9 percent of GDP in FY22 (Figure 3.1 and Figure 3.2).34 Over the past decade,
increasing the deficit averaged 6.2 percent of GDP, a notch below the South Asia regional average
of 6.3 percent (Figure 3.2).35 The fiscal sustainability challenge is also inter-linked with the
constitutionally defined fiscal arrangements between federal and provincial governments
that have created persistent structural deficits. The 18th Constitutional Amendment in
2010 and the 7th NFC Award have resulted in significant vertical fiscal asymmetry leading
to larger (total) fiscal and primary fiscal deficits. According to the 7th NFC Award,
approximately three-fifths of the consolidated revenues accrue to the provinces,36 while
the Federal Government assumes responsibility for two-thirds of total general
government expenditures. As a result, the large recurrent budget shortfalls have led to
rapid accumulation of public debt (including guaranteed debt), which reached 82.3
percent of GDP in FY23, slightly lower than the record high public debt of 84.0 percent

34 In this section, FY23 fiscal outcomes are reported as share of World Bank estimated GDP for FY23.
35 Due to the pandemic and recent surges in commodity prices, fiscal deficits across the region have trended higher, most acutely in major
oil-importing countries, such as Pakistan.
36 7th NFC Award sets vertical share of provinces in federal divisible pool at 57.5 percent, up from 46.5 percent in the previous award. As per

the 18th Constitutional Amendment, the share of the provinces in subsequent awards cannot be less than their share in the previous award.

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 Restoring Fiscal Sustainability Pakistan Development Update

of GDP in FY20. Accordingly, both the deficit and debt levels are in breach of the fiscal
rules stipulated by the Fiscal Responsibility and Debt Limitation Act (FRDLA).37
Figure 3.1: Pakistan: General Government Budget Figure 3.2: South Asia: General Government Budget
Balance Balance
(Percent of GDP) (Percent of GDP)
-2

-3
0
-4
-2 -0.7
-5
-4 -3.2
-3.9
-6
-6
-6.3 -6.1
-7
-8 -7.4
-7.9
-8 -10 FY13-FY17 Average
-9.2
FY18-FY22 Average
-9 -12
FY13-FY22 Average
FY08

FY15

FY22
FY06
FY07

FY09
FY10
FY11
FY12
FY13
FY14

FY16
FY17
FY18
FY19
FY20
FY21

FY23
-12.0
-14
Source: Ministry of Finance and World Bank staff calculations. Source: World Bank, 2023b.
Note: SAR = South Asia Region.

High public debt has Extensive credits from the Figure 3.3: Credit to the Private Sector
crowded out private financial sector to the (Percent of GDP)
investment, leading Government have crowded 160 2000 2005 2010 2015
to lower potential out private sector lending.
140 2020 2021 2022
growth in the Credit extended by the
extended term banking sector to the 120
Government has risen by 100
more than 400 percent over 80
FY11–21.38 Meanwhile,
private sector credit in 60
Pakistan has fallen to 14.8 40
percent of GDP in 2022, one 20
of the lowest among
0
emerging economies (Figure
3.3). The reduced access to
credit is one of the main
contributing factors for the
Source: World Development Indicators and World Bank, 2022.
low levels of private
investment and hence low productivity growth in Pakistan,39 in turn leading to lower
potential growth over the medium and long term.

c. Revenue Mobilization Challenges

Despite various In FY23, Pakistan’s aggregate revenue stood at 11.6 percent of GDP, with 92 percent of
reform efforts, revenues collected at the federal level and remaining at the provincial level (Figure 3.4).
revenue collection The tax-to-GDP ratio reached just 10.2 percent in FY23. Although Pakistan’s tax revenue
remains low in performance improved between FY11–18, rising from a low of 8.6 percent of GDP in
international FY11 to a high of 11.4 percent in FY18, it still falls short of 15 percent of GDP, which is
comparison considered the minimum required tax revenue by developing countries to fund basic

37 The FRDLA stipulates a fiscal deficit ceiling of 3.5 percent of GDP and a debt ceiling of 60 percent of GDP. However, the fiscal deficit
has consistently exceeded 3.5 percent of GDP since FY06, and the public and publicly guaranteed debt-to-GDP ratio has remained above 60
percent since FY16.
38 Includes investments in government securities, direct lending for commodity operations, and lending to SOEs.
39 World Bank (2022) Pakistan Development Update.

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 Restoring Fiscal Sustainability Pakistan Development Update

government functions.40 It also falls below the tax collections of middle-income and low-
income countries, and—more importantly—the level needed to reduce the country’s
budget shortfalls and create fiscal space for public spending on infrastructure, education,
and health.
Figure 3.4: Total Revenue, by source and year Figure 3.5: Tax Revenue, by source and year
(Percent of GDP) (Percent of GDP)

Total Revenue Federal Revenue Provincial Revenue FBR Taxes Other Federal Taxes Provincial Tax Revenue

16 12 11.211.211.4
9.9 10.210.010.310.410.2
14 8.9 8.6 9.2 8.9 9.3
10
8.3 8.0 8.3 8.2
12
8
10
8 6
6
4
4
2
2
0 0
FY09

FY17

FY06

FY13

FY20
FY06
FY07
FY08

FY10
FY11
FY12
FY13
FY14
FY15
FY16

FY18
FY19
FY20
FY21
FY22
FY23

FY07
FY08
FY09
FY10
FY11
FY12

FY14
FY15
FY16
FY17
FY18
FY19

FY21
FY22
FY23
Source: Ministry of Finance and World Bank staff calculations. Source: Ministry of Finance and World Bank staff calculations.

Federal tax Federal tax revenues, mainly collected by the Federal Board of Revenue (FBR, Figure
collection relies 3.5), increased between FY06–23 but with significant fluctuations. The share of direct
primarily on indirect taxes (income and corporate taxes) in FBR revenues averaged 38.4 percent between
and withholding FY06–23, whereas the remaining 61.6 percent came through indirect taxes, namely excise
taxes, while duties, sales tax on goods, and customs duties. In addition, income tax receipts come from
provincial tax a small number of taxpayers; in FY22 the number of taxpayers that filed tax returns was
collection remains just 3 million (1.2 percent of the total population). In the same fiscal year, 67 percent of
critically low income tax receipts were collected by withholding agents such as banks and telecom and
utility companies.41 Income tax collected in this manner essentially becomes an indirect
tax and is regressive as some of these taxes can be passed on to consumers. For instance,
advance tax on imports and contracts is a major contributor to the withholding taxes and
gets added to the final price of a good or service. Similar to federal tax revenue, provincial
tax revenue has increased over the years but remains significantly low. Since the 18th
Constitutional Amendment, provincial tax revenues increased from 0.3 percent of GDP
in FY10 to 1.0 percent of GDP in FY18, largely on account of GST on services, but since
then have declined to 0.8 percent of GDP in FY23. Provincial tax revenue accounted for
only 7.7 percent of overall tax revenue collection in FY23.

Weak revenue Pakistan’s tax system is complex, has a narrow tax base, and high tax rates. The tax system
performance reflects has numerous special provisions, concessional rates, exemptions, and, to some extent,
the structure of the unorthodox approaches to tax policy. Many of these policy choices were implemented to
tax system balance the provision of fiscal support to certain groups or industries with the need to
maintain a minimum level of revenue collection. This has resulted in a complex system
with many vested interests and has come at the cost of losing economic efficiency and
revenue.

Tax exemptions The GST base definition is narrow, with multiple exemptions permitted. The sales tax
result in significant system allows for concessionary rates below the standard 18 percent for select products
revenue loss and sectors. It also allows certain domestic supplies to be zero-rated, which further
narrows the tax base. A value-added tax gap analysis based on 2019 data reveals that
concessionary tax rates, exemptions, and zero ratings for non-exported products cost

40 United Nations Committee of International Experts on International Cooperation in Tax Matters (2018) The Role of Taxation and Domestic
Resource Mobilization in the Implementation of the Sustainable Development Goals, p.3; Gaspar, Jaramillo, and Wingender (2016) Tax Capacity and Growth,
p.30.
41 State Bank of Pakistan (2022a) Annual Report 2021–22.

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 Restoring Fiscal Sustainability Pakistan Development Update

Pakistan 15 percent of its revenue potential.42 In FY22, Pakistan lost a total of 2.6 percent
of GDP to tax concessions, 0.2 percentage points more than in FY20. Between FY20 and
FY22, Pakistan annually lost an average of 26, 18, and 30 percent of sales tax on goods,
income tax, and customs duty revenue potential, respectively, to concessionary rates and
exemptions. Moreover, due to the challenges associated with having a large informal and
undocumented economy, retailers are largely able to avoid taxation despite having an
annual turnover exceeding the legal threshold for sales tax registration.

The corporate Corporate income tax (CIT) rates differentiate between three different regimes with
income tax is different tax rates and special provisions applied to standard companies, small firms, and
complex and features SMEs in the manufacturing sector. These differentiations generate incentives for firms to
numerous split or stay small. Additionally, Pakistan provides certain firms access to a simplified
preferential schemes turnover tax regime, which is both financially lucrative for the firms and reduces
incentives for them to invest in accounting systems, business formalization, and
expansion. The CIT regime also provides for various tax incentives. These include
outright tax holidays, reduced rates, credits, and exemptions granted by sector, investment
type, and location. Pakistan’s thin-cap provisions only have limited coverage, opening
opportunities for firms to reduce their tax liabilities.43

Federal excise duty Pakistan collected 0.5 percent of GDP in federal excise duty revenue in FY21. The
collection on taxation of cigarettes was the main contributor to this and accounted for 0.19 percent of
cigarettes lies below GDP, which has remained relatively steady in recent years. Cigarettes are taxed through
its potential a dual rate. A substantial revenue gain of 0.4 percent of GDP could be achieved if the
current rate on premium cigarettes (PKR 16.50 per cigarette) was also applied to standard
cigarettes.

Potential provincial Pakistan’s provinces are assigned three significant sources of revenue: sales tax on
revenue sources services, agricultural income taxation, and property taxation. The World Bank’s and the
remain IMF’s respective tax policy reviews44 have analyzed agricultural income taxation and have
underutilized, highlighted the resulting fractionalization of the income tax base due to the split between
including agriculture federal and provincial governments45 and the exceptionally low revenue performance,46
and property despite the agricultural sector’s substantial contribution to GDP. Property taxation, which
taxation is a shared responsibility between provincial, district, and town governments, has low
collection rates driven by valuation tables47 that understate current market values and/or
the potential income from property, especially for self-occupied property.48 More recent
academic literature on provincial property taxation has highlighted that property tax
collectors face few incentives to raise revenue.49

Pakistan’s fiscal Priority reforms to address the challenges identified above include: i) drastic reduction of
sustainability hinges tax exemptions; ii) expansion of the tax base to increase progressive taxation of agriculture
on revenue reforms income, property, and retailers; and iii) increasing excise taxes on tobacco products and
other socially harmful products.

d. Expenditure Management Challenges

Pakistan’s prevailing Pakistan relies heavily on liability-financed expenditure to meet recurrent spending
structure of public obligations and to achieve short-run policy objectives. Rigidities in government

42 World Bank (2023b) Pakistan Federal Public Expenditure Review.

43 Thin-cap provisions regulate firms that are financed by a relatively high portion of debt compared to equity. In such circumstances, interest
expenditure is high, which reduces firms’ tax liability. Thin-cap provisions limit the amount of interest that can be deducted in calculating the
taxable profits, thereby preventing companies from avoiding tax liabilities through excessive debt.
44 World Bank (2018) Pakistan Tax System – Tax Policy Review; IMF (2019) Redesigning Pakistan’s Tax System.
45 The FBR estimates that the fractionalization of the tax base cost the Federal Government more than PKR 69 billion in foregone revenues

in 2020. Source: Federal Board of Revenue (2020) Tax Expenditure Report 2020.
46 Nasim (2012) “Agricultural Income Taxation.”.
47 With the support of the World Bank Resilient Institutions for a Sustainable Economy development policy operations, federal and provincial

property valuations were recently adjusted higher to better reflect market valuations.
48 World Bank (2017) “Annual Report 2016–17. Sindh Annex 6 – Property Tax Study”; World Bank (2018) Pakistan Tax System – Tax Policy

Review.
49 Khan, Khwaja, and Olken (2016) “Tax Farming Redux.”; Khan, Khwaja, and Olken (2019) “Making Moves Matter.”

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 Restoring Fiscal Sustainability Pakistan Development Update

expenditure poses expenditures constrain efforts to reprioritize public spending towards development
risks to fiscal targets. The share of recurrent expenditure in total general government expenditure has
sustainability increased from 79.5 percent of total consolidated expenditure in FY15 to 88.2 percent in
FY23 (Figure 3.6). Meanwhile, the share of development expenditure has significantly
dropped from 20.5 percent of total outlays to 11.8 percent over this period. Consisting
mostly of rigid expenditures such as debt servicing, pensions, and wages, recurrent
expenditure has increased at both the federal and provincial level as a share of total outlays
(Figure 3.7). As a result, spending does not lead to a significant growth dividend and
instead risks perpetuating a cycle of increasing debt and debt service expenditure.
Figure 3.6: Recurrent and Development Expenditure Figure 3.7: Federal Government Spending, Economic
(Percent of total general government spending) Classification
(Percent of GDP)
Loans and Advances
Provincial Development Expenditure Interest
Federal Development Expenditure Grants, Subsidies, Writeoffs, Advances and Transfers
Provincial Current Expenditure Operating Expenses
Federal Current Expenditure Capital
100% Salaries, pensions and other benefits
15% 13.52%
Total Expenditure and Loans
80%

60% 10%

40%

5%
20%

0%
FY06
FY07
FY08
FY09
FY10
FY11
FY12
FY13
FY14
FY15
FY16
FY17
FY18
FY19
FY20
FY21
FY22
FY23

0%
FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22
Source: Ministry of Finance and World Bank staff calculations. Source: Government of Pakistan and World Bank staff calculations.
Note: Due to unavailability of accurate data, similar disaggregation
has not been provided for provincial governments.

Interest payments Interest payments to service the country’s public debt are the primary driver of the
are increasingly Government’s current spending.50 Over the last 10 years, interest spending averaged 4.7
accounting for the percent of GDP per year and jumped to 7.0 percent of GDP in FY23 from 4.8 percent in
largest share of FY22. The share of interest payments in total current spending reached 40 percent in
current spending FY23—the highest in the last 10 years. The burden of interest payments falls primarily on
the Federal Government as it relies heavily on borrowing from domestic commercial
banks and more recently, on external commercial loans and Eurobonds and International
Sukuk. The recent hike in domestic policy rates combined with the weaker currency has
significantly increased interest payments for the Federal Government. Conversely,
provinces have predominantly relied on concessional financing from multilateral
development institutions. As a result, provincial borrowing costs have remained low, but
increased recently with the weakening currency.
Together, the wage Spending on public sector staff, including on salaries and pensions, accounts for around
bill and pension 2.0 percent of GDP per year and 15 percent of total spending in FY22.51 Fiscal costs for
expenses are one of Pakistan’s civil servants’ pension schemes have dramatically grown over the past several
the largest spending years and risk further increase over the coming years driven by ad hoc indexation that is
drivers much higher than inflation, historical growth in civil service headcount, and liberalization
of the eligibility requirements for benefits such as the survivorship benefits. In comparison
to South Asian peers, Pakistan’s pension expenditure as share of GDP at 1.7 percent is
estimated to be the highest in the region. Bangladesh has the lowest pension bill at 0.6
percent of GDP whereas Sri Lanka has the second highest pension expense, after Pakistan,
at 1.4 percent of GDP.52 A comprehensive review of Pakistan’s compensation structure is
critical to identify the necessary reform measures to achieve sustainability and fairness.

50 Pakistan treats principal repayments on public debt as below-the-line. As a result, principal payments are not included in the expenditure
analysis.
51 World Bank Database on Pensions GP Social Protection. Figures ranged from 2011 to 2018 (latest available).
52 Based on data availability, the year of comparison varies for each country.

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 Restoring Fiscal Sustainability Pakistan Development Update

General subsidies are The Federal Government relies on poorly targeted and regressive subsidies to provide
very costly and social and economic support. Between FY12 and FY22, subsidy spending averaged 1.1
distortive percent of GDP. It increased significantly to 2.3 percent of GDP in FY22 before
moderating to 1.3 percent in FY23 as the Government took steps to eliminate new
subsidies on fuel and electricity prices and improved targeting and distribution of subsidies
on electricity.53 The misaligned energy subsidies combined with low-cost recovery and
poor performance and inefficiency of electricity and gas distribution companies have
created a growing financial deficit for the country. In comparison to high public spending
on subsidies, the allocation for BISP in the FY24 budget is only 0.6 percent of GDP.54
Provincial government spending on subsidies is primarily on agriculture, including wheat
procurement operations, tubewells, and fertilizers. Overall, both federal and provincial
subsidies are distortive and regressive, and the benefits largely accrue to the non-poor.55
With operational The federal SOE portfolio has been incurring net losses since FY16 that average around
costs higher than 0.5 percent of GDP annually, with the top 14 loss-making SOEs incurring an annual fiscal
their revenues, loss- cost of 0.8 percent of GDP (PKR 458 billion).56 As a result, federal annual fiscal support
making SOEs have to the SOEs, in the form of equity injections, subsidies, and loans, has been substantial
been a major drain and growing, reaching 1.4 percent of GDP in FY21. In addition, many government loans
on fiscal resources to SOEs are overdue and not being serviced. Hence, the stock of outstanding government
domestic loans to SOEs stood at 3.5 percent of GDP in FY21, of which nearly one-third
was overdue. Moreover, contingent liabilities, in the form of loan guarantees provided by
the Federal Government for SOEs to seek commercial loans, have been rapidly rising and
were almost 4.5 percent of GDP at end-FY21. Information on tax and dividend arrears is
not readily available but taxes and dividends from SOEs averaged just 0.4 percent of GDP
during FY16–21—significantly lower than government direct transfers to the SOEs (1.3
percent of GDP).
In contrast, public Since the 18th Constitutional Amendment in 2010, public spending on education and
spending on human health has gradually increased but remains low relative to international norms. Together,
capital is low and at Pakistan’s public spending on education and health was 3.4 percent of GDP in FY20, one
risk of being further of the lowest in South Asia and significantly lower compared to the global average of 11.2
curtailed given fiscal percent.57 Public spending on education improved from 1.6 percent of GDP in FY10 to
pressures 2.1 percent in FY18, whereas spending on health grew from 0.5 percent to 1.1 percent of
GDP during the same period. However, more recently, public spending on the two areas
has declined, reaching 1.7 percent of GDP on education and 1.4 percent on health in
FY22.58 This partly reflects the impact of high fiscal sustainability pressures, rising
predominantly from rigid and increasing current expenditure.
Development Despite the importance of public investment for economic growth, development spending
expenditure yields is small and declining, partly due to narrowing fiscal space in the context of increasing
limited growth interest payments.59 In FY23, spending under the PSDP was equal to only 2.2 percent of
impact and is GDP, down from 4.4 percent of GDP in FY17. In addition, studies have shown that the
crowded out by growth impact of development spending is limited, due to consistently low levels of
interest payments development expenditures, weak prioritization, and delays and spending irregularities.60
Urgent reforms are Priority reforms to address the challenges identified above include: i) reducing regressive
needed to rationalize subsidy spending, especially in energy and agriculture; ii) improving the financial viability
and improve the of the power sector by lowering generation costs, raising cost recovery, and reducing
inefficiency and losses in distribution; iii) applying austerity measures to limit government

53 The Government has created two categories of “protected” and “unprotected” consumers in tariff distribution structure. This should help
improve targeting of power sector subsidies with progressively higher tariffs applied on unprotected consumers, based on their consumption.
54 Reported as share of government estimated GDP for FY23.
55 World Bank (2023b) Pakistan Federal Public Expenditure Review.
56 Excluding health and education institutions, the federal SOE portfolio comprises 207 enterprises, of which 87 are commercial enterprises

operating in various economic sectors, and 47 are non-commercial enterprises. Punjab has 224 SOEs (including 49 public sector companies)
and KP has 121 SOEs (including six public sector companies). No information is available regarding the SOE portfolios of Sindh and
Balochistan.
57 World Development Indicators.
58 Ministry of Finance (2023b) Pakistan Economic Survey FY2022–23.
59 World Bank (2023b) Pakistan Federal Public Expenditure Review.
60 Ul Haque et al. (2020) Doing Development Better.

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quality of public staff and operational costs; iv) reviewing and consolidating PSDP allocations; v)
spending implementing broader measures to introduce private participation in the SOE sector,
including through selective privatization of SOEs operating in sectors open to
competition; vi) constraining growth of pension spending; and vii) improving public
investment management to ensure prioritization of sound public investment projects.

e. Debt Management Challenges

Pakistan’s public The public debt stock, including guaranteed debt, reached 82.3 percent of GDP at end-
debt stock is high FY23, increasing from 58.4 percent of GDP at end-FY12 (Figure 3.8). These debt levels
and growing, leading breach the thresholds defined in the FRDLA 2022, which requires public debt to be at
to high gross most 60 percent of GDP by end of FY23. Pakistan’s general government debt has grown
financing needs sharply compared to economic peers, including Indonesia, South Africa, Thailand, and
Türkiye (Figure 3.9). The growing debt stock imposes high fiscal costs and exposes the
country to debt vulnerabilities. The persistent fiscal deficits and debt repayments have
maintained high annual gross financing needs, averaging 27 percent of GDP over the last
decade—significantly higher than the emerging market threshold of 15 percent.
Figure 3.8: Pakistan’s Public and Publicly Figure 3.9: General Government Debt to GDP
Guaranteed Debt (Average annual GG debt, as a percent of GDP)
External Debt (as percent of GDP) 2010-2015 2016-2021
Domestic Debt (as percent of GDP)
FRDLA Debt to GDP Threshold 89
100 Public Debt (PKR billion) 75,000
81 84 78 80.7 82.3 77
71 72
68
Debt as percent of GDP

80 68 60,000
Debt in PKR billion

63 64 57 60 57
58 59 59 60 30 32 28 32 34
60 45,000 46
23
18 20 19 41
23 20 19 39
40 30,000 33 33 33
25
52 50 49 49
44 44 45 51
20 35 39 41 42 15,000

0 -
FY16
FY12
FY13
FY14
FY15

FY17
FY18
FY19
FY20
FY21
FY22
FY23

Pakistan India Indonesia Turkey Thailand Sri Lanka South

Africa
Source: World Bank staff calculations. Source: IMF 2022 and World Bank staff calculations.

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 Restoring Fiscal Sustainability Pakistan Development Update

The composition of Pakistan’s reliance on floating rate Figure 3.10: Drivers of Pakistan’s Public and
Pakistan’s public domestic debt instruments and a Publicly Guaranteed Debt
debt exposes it to comparatively high share of external Residual
Other debt-creating flows
interest rate and borrowing exposes the country to Exchange rate depreciation
exchange rate shocks macroeconomic risks. As a result, 20
Real interest rate
Real GDP growth
between 2013 and 2023, exchange Primary deficit
rate depreciation contributed a Change in gross public sector debt
cumulative 28.9 percentage points of 10
GDP to the public and publicly
guaranteed debt, of which 24.3 0
percentage points occurred over four
years in FY19–23 (Figure 3.10).
-10
Although the contribution from
interest rate changes was negative
over the same period—contributing -20

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023
to a reduction of the debt stock—this
was more than offset by the Source: Ministry of Finance and World Bank staff
revaluation losses due to exchange calculations.
rate depreciations.
The lack of an The fragmentation in debt management has resulted in insufficient coordination among
integrated debt the various institutions involved, leading to suboptimal borrowing choices and a
management disconnect between debt management strategy design and implementation. The Debt
function undermines Management Office (DMO) remains severely understaffed despite the recent reforms to
sound debt establish a unified DMO. The lack of a centralized Debt Management Information
management and System (DMIS) underscores how debt management operations are being recorded and
leads to suboptimal managed by four institutions in three different systems (and an Excel database) that are
borrowing choices not linked electronically. In addition, critical lagging debt management areas include: i)
insufficient information sharing among the SBP, the Budget Wing of the Finance
Division, and the DMO on current and future debt transactions, and central government
cash flows; ii) lack of effective cash forecasting; iii) the unavailability of business
continuity and disaster recovery plans across the entities that register debt records; and
iv) lack of in-depth assessment and monitoring of fiscal risks.

Shallow domestic Pakistan’s largely under-developed domestic market has constrained borrowing sources
debt markets have and instruments, leading to high debt servicing costs. Despite the increase in domestic
also impacted debt from 31 percent of GDP in FY11 to 46.7 percent of GDP in FY23, the investor
borrowing choices base largely remains limited to commercial banks. In addition, the Government has been
and sources increasing the domestic debt issuances of floating rate debt, which has raised the interest
burden in recent years. Almost 70 percent of the domestic debt by end-June 2023 was
issued on floating interest rates. The development of the domestic debt capital market
remains critical in diversifying the investor base, which can help in maximizing long-term
domestic borrowing potential.

Debt management Priority reforms to address the challenges identified above include: i) strengthening DMO
reforms are critical to staffing; ii) improving debt transparency through enhanced debt publications; iii)
managing rising improving debt recording systems by integrating all existing databases; iv) improving
fiscal costs and risks recording and reporting of fiscal risks and contingent liabilities; v) improving cash
management and forecasting by implementing the Treasury Single Account (TSA); and
vi) developing the domestic debt market through both supply and demand side
interventions aimed at expanding the investor base and primary dealership system for
auction of government securities, and issuing more debt instruments of varying maturities
to meet investor demand.

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f. Fiscal Federalism Challenges

The 18th The 18th Constitutional Amendment promulgated in 2010 and the 7th NFC Award that
Constitutional preceded it established the framework for fiscal decentralization in Pakistan. Considered
Amendment and 7th to be the most far-reaching reform in the country’s constitutional history, it significantly
NFC Award increased the overall share of sub-national governments in the country’s revenues and
represented major reestablished fiscal autonomy of the provinces in taxing and spending decisions. The 18th
steps forward with Constitutional Amendment abolished the Concurrent Legislative List (CLL),61 devolving
the devolution nearly all 47 responsibilities of the CLL to the provinces. It also strengthened the role of
agenda… key constitutional bodies, including the Council of Common Interests (CCI)62 and the
National Economic Council (NEC)63 to coordinate intergovernmental relations.

…but resulted in The 7th NFC Award was approved before the 18th Constitutional Amendment, with
important challenges financing arrangements therefore not informed by service delivery responsibilities. As a
result, the revenue mobilization and expenditure responsibilities at the federal and
provincial level are not aligned and lead to recurrent budget shortfalls. Progress with
implementing the devolution agenda has stalled since the 18th Constitutional Amendment,
with current arrangements distorting incentives and accountabilities and impeding
performance, both at the federal and provincial levels.
• Because formal responsibility for delivering most services resides with the provinces,
and around one-half of federal revenues are transferred to provinces, the Federal
Government faces weaker incentives to raise revenues.
• Because provinces receive funds from the federal divisible pool regardless of service
delivery performance, they face few incentives to bear the political cost of imposing
additional taxes or even collecting existing taxes.
• Because the Federal Government continues to devote significant resources to
spending in formally devolved areas, there are substantial overlaps and major
problems of coordination in service delivery.64 Public accountability for service
delivery and economic development is weakened at both the provincial and federal
levels. Provinces have therefore used additional fiscal space from increased transfers
to increase recurrent spending, especially on payroll and pensions, leaving
development spending unchanged.
• In the absence of effective coordination, constitutionally fragmented tax bases have
further constrained effective tax policy and administration. The sales tax base is
fragmented between tax on goods and on services, the former legislated and
administered by the Federal Government and the latter under the purview of the
provinces. Similarly, the income tax base is fragmented between agriculture income
(provincial tax base) and non-agriculture tax (federal tax base).65 The constitutional
division of taxing powers has impacted authorities’ ability to legislate, implement, and
reform a coherent tax policy. It has also led to tax arbitrage and tax evasion and an
enormous tax compliance challenge for businesses. In addition, the lack of adequate
data-sharing protocols between the federal and provincial tax agencies hinders
enforcement, creating even more opportunities for tax avoidance, especially in
income taxation.

61 The 1973 Constitution introduced a CLL of responsibilities shared by the provinces and the Federal Government with the intention of
giving provincial governments time to build capacity to take on these responsibilities. Over time, almost 47 subjects were included in the
CLL.
62 The CCI is a constitutional body established through the 1956 Constitution for inter-provincial coordination and conflict resolution. Its

composition was changed to include the Prime Minister as the Chairperson and the Council is required to meet at least once every 90 days.
63 The NEC is also a constitutional body mandated with oversight of national economic policies. The Council is required to meet at least

once every six months.

64 Federal expenditure on the devolved areas has increased slightly between FY09—the fiscal year before the 18th amendment was enacted

—and FY22, from 0.4 to 0.5 percent of GDP. It primarily includes vertical programs that directly provide services in the provincial domain.
Most prominent among these is BISP, for which federal spending has increased consistently since its inception in FY09, peaking at 0.52
percent of GDP during the COVID-19 pandemic in FY20.
65 Among direct taxes, the Federal Government is tasked with collecting personal and corporate income tax (except for income derived from

agriculture) and capital value tax (excluding immovable property), whereas among indirect taxes it collects custom duties, federal excises, and
the GST on goods. The provinces are assigned the following direct taxes: urban immovable property tax (UIPT), agricultural income tax, and
capital gains tax (on property). In indirect taxes, provinces have the authority over GST on services, tax on professions, motor vehicle tax,
and stamp duty, among others.

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Current fiscal The country’s existing fiscal institutions and intergovernmental coordination
federalism arrangements have constrained the effective management of the Government’s finances.
arrangements do not Fiscal policy making is fragmented across numerous bodies,66 resulting in institutional
provide a framework gaps that contribute to the lack of focus on achieving sustainable fiscal outcomes at the
for a coordinated national level. Pakistan’s fiscal legislation, the Fiscal Responsibility and Debt Limitation
national fiscal policy (Amendment) Act 2022, limits Pakistan’s public debt GDP ratio below 60 percent of
GDP and makes preparation of a national Medium-Term Fiscal Framework mandatory.
However, the law lacks safeguards against the violations of these thresholds. The lack of
a consolidated medium-term framework to anchor both federal and provincial budgets
and fiscal targets results in incremental budgeting and a lack of coherence between the
objectives of the federal and provincial governments, contributing to sizable recurrent
fiscal deficits.

Devolution remains To resolve constraints arising from current fiscal institutional arrangements, action is
an incomplete needed to: i) strengthen coordination and coherence between federal and provincial fiscal
agenda policies, including through enhanced cooperation on tax policy and administration,
service delivery, and fiscal policy; and ii) amend the revenue sharing arrangement to
ensure that resources commensurate with responsibilities. Institutions like the CCI and
NEC should play a more active role in shaping a common fiscal framework.

Strengthening the Priority reforms to address the challenges identified above include: i) resurrecting
fiscal federalism institutions for fiscal coordination, including the CCI; ii) implementing legal reforms to
framework is crucial support a national fiscal policy; iii) limiting federal spending within provincial mandates
for long-term fiscal to reduce federal expenditures and improve accountabilities for service delivery; iv)
sustainability developing a national tax policy and strengthening federal–provincial coordination on tax
policy; and v) revisiting the 7th NFC Award in order to ensure that financing is aligned
with functions for provincial and federal governments.

g. Roadmap for Addressing Fiscal Constraints

Pakistan needs a Pakistan’s large and persistent fiscal deficits threaten sustainability, stability, and economic
broad-based fiscal growth. Weaknesses in revenue and expenditure policies have contributed to economic
reforms agenda to imbalances, distorted resource allocation, and constrained productivity growth. A broad
spur sustainable program of policy reforms should be immediately implemented: to i) achieve substantial
economic growth fiscal consolidation and safeguard macroeconomic sustainability; ii) address systematic
and strengthen the resource misallocation arising from distortive tax policies; and iii) improve the quality of
pace of economic spending, with reduced allocations to administrative costs and regressive subsidies. These
recovery reforms will ultimately increase fiscal space for pro-growth, pro-poor spending on basic
services, social protection, and development needs.

Table 3.1: Policy Recommendations

Priorities Recommendations
A. Priorities for I. Reduce sales tax exemptions and strengthen administration.
Improving a. Remove concessional rates: Remove concessional rates on sales tax on goods through
Revenues the elimination of the 8th schedule of the Sales Tax Act and apply the standard rate on
all goods subject to reduced rates.
b. Limit zero ratings: Limit the list of goods subject to zero-rating exclusively to exports
only. All domestically sold goods mentioned in the 5th schedule of the Sales Tax Act
could initially be moved to the exempt list under the 6th schedule before exemptions are
also rationalized.
c. Limit exemptions: Reduce items included in the 6th schedule of the Sales Tax Act,
limiting exemptions only to those considered as basic food, basic public health services,
and selected financial transactions.

66Fiscal policy-making institutions at the federal level include the Finance Division, FBR, and Ministry of Planning. At the provincial level,
the fiscal policy-making institutions for each province include the Finance Department, Planning Department, Revenue Authority, Board of
Revenue and Excise Department. Therefore, there are at least 23 institutions involved with fiscal policy making at the national level.

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d. Increase revenue from retailers: Strengthening tax administration to bring retailers

with an annual turnover above the legally defined threshold under the Sales Tax Act into
the tax system.
II. Increase cigarette excise duty.
a. Collapse the two tiers structure into a single rate and levy the premium excise tax rate,
applied on an ad-valorem basis to allow automatic indexation to inflation.
III. Reduce import duty exemptions.
a. Remove import duty exemptions for non-exporters under the 5th schedule of the tariff
code.
IV. Increase, improve, or implement new taxes on property and agriculture.
a. Reform agriculture tax:
i. Reduce or refine the current 12 ½ acre tax exemption threshold to bring more
agricultural land into the tax net.
ii. Ensure appropriate categorization of land for tax rates, taking into account size,
location, and irrigation status (simulations of an acreage-based tax indicated a
potential to generate additional provincial revenues of around 1 percent of GDP).
This also extends to agricultural land being used for non-agriculture purposes but
continues to be taxed under agriculture income tax scheme, leaving opportunities
for tax arbitrage.
b. Strengthen property tax collection:
i. Increase property tax rates to match those applied in peer economies (in Punjab,
for example, the UIPT rate is currently set at 5 percent of the annual rental value,
which translates into a capital value-based tax rate of 0.07 percent, compared to 0.5
percent in many low-income countries).
ii. Harmonize the three valuation systems being used for different land-related taxes,
with tax rates based on capital values that are reflective of market prices,
iii. Continue or complete the establishment of reliable records of land ownership
linked to Computerized National Identity Cards (CNICs) and National Tax
Number.
iv. Improve the policy and legal framework to ensure that sizable and growing peri-
urban settlements outside current notified municipal boundaries are also subject to
appropriate land taxation.

B. Priorities for I. Reduce regressive subsidy spending.

Rationalizing a. Reduce electricity subsidies: Further improve the targeting of and eliminate electricity
Expenditures subsidies to achieve full cost recovery for non-protected consumers. Reduce power
generation and transmission costs of the power sector, while improving cost recovery.
b. Reduce natural gas subsidies: Further improve the progressivity of the gas tariffs by
reducing subsidies to richer households and compensating poorer households through
higher cash transfers under BISP.
c. Remove or reduce other distortionary subsidies: Remove or reduce regressive and
distortive subsidies on i) petroleum, ii) tube-well, iii) wheat support price, and iv)
fertilizers.
II. Apply austerity measures to limit government staff and operational costs: The
Government could consider implementing government-wide hiring and wage freezes and
other measures such as halting vehicle purchases and limiting extra allowances for all staff
to manage rapidly growing staff and operational costs.
III. Consolidate federal PSDP allocations: Conduct a review of PSDP development
expenditure and cancel all projects that have not undergone proper project preparation,
selection, and prioritization, as well as delay previously vetted projects that are unlikely to
bring any benefits to the poor.
IV. Divest or restructure SOEs through increased private participation.
a. Implement the recommendation of the 2021 triage exercise: Divest loss-making
SOEs, especially those in sectors where there is no clear rationale for government
involvement.
b. Strengthen SOE governance: Strengthen SOE governance through the
implementation of the new SOE law, strengthening the capacity of the SOE Central
Monitoring Unit for improved financial management and performance, and by
institutionalizing performance monitoring.
c. Reduce SOE subsidies: Discontinue subsidies to SOEs that do not provide a public
good benefit.

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d. Cut lending to SOEs: Enforce all SOE loan agreements and establish stringent
processes and criteria for evaluating SOE loan requests, including reviews of assets that
can be collateralized and repayment capacity.
V. Constrain the growth of pension spending through:
a. Automatic indexation to inflation, subject to a cap.
b. Instituting a minimum retirement age to receive benefits.
c. Circumscribing dependents eligible for survivorship benefits.
VI. Strengthen public investment management: Fully implement the Public Financial
Management (PFM) Act of 2019, including a comprehensive economic and risk assessment
of development projects. Establish a monitoring and evaluation system for public investment
projects and programs.

C. Priorities for I. Improve debt management institutions and capacity through strengthening:
Improving Debt a. DMO staffing: Complete staffing of the DMO as envisioned under the FRDLA 2022.
Management b. Debt publications: Publication of annually updated Medium-Term Debt Management
Strategy, annual borrowing plan, annual debt review, and semi-annual debt bulletins by
the DMO.
c. Debt recording systems: Installation of a DMIS at the DMO that links all databases
recording debt related transactions.
d. Fiscal risk assessment and contingent liabilities: Analyze and appropriately disclose
fiscal risks, including natural disasters and implicit contingent obligations such as circular
debt settlements, and commodity operations through a fiscal risk statement.
II. Adopt the TSA: Rollout TSA for proper monitoring, accounting, and forecasting of the
Government’s available cash balance, which can decrease public borrowing requirements.
III. Develop the domestic debt market: Development of domestic debt capital market to
increase the maturity profile of domestic debt stock and lower the cost of domestic
borrowings through:
a. Enabling a larger investor base to participate in public auction of government securities
and their subsequent trading to diversify and expand the current group of primary
dealers appointed by the SBP.
b. Issuance of broader range of government securities to meet varying demands of a
diversified investor base, while improving liquidity management for the Government.

D. Priorities for I. Resurrect institutions for fiscal coordination: Strengthen the role of the CCI to act as a
More Effective forum for continuous intergovernmental dialogue. Set up the CCI Secretariat as mandated
Fiscal by the Constitution and phase out the inter-provincial coordination ministry.
Federalism II. Implement legal reforms to support national fiscal policy: Align federal and provincial
fiscal and debt legislations and establish coordination mechanisms for the effective
implementation of a national fiscal policy.
III. Limit federal spending on devolved areas: Transfer spending responsibilities on devolved
areas to provinces, including health, education, and social spending.
IV. Develop a national tax policy to facilitate higher provincial own-source revenue to
finance expanded priorities.
V. Enhance federal–provincial coordination on tax policy: Establish formal and informal
mechanisms such as tax policy round tables to foster dialogue between federal and provincial
governments on key issues related to tax policy and administration. Use such forums to align
tax regulatory regimes where needed and institutionalize data-sharing arrangements to
strengthen revenue generation.
VI. Revisit the 7th NFC to ensure that financing commensurate with responsibilities.
a. Revenue sharing arrangements should incentivize higher tax revenue collection, and
provincial governments should finance a much larger share of expenditure through
own-source revenue.
b. Enhance the capacity of the NFC Secretariat to foster dialogue amongst the federating
units on matters relating to fiscal transfers, performance grants, and cross-cutting PFM
issues.

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References

Barriga-Cabanillas, Oscar, Shabana Kishwar, Moritz Meyer, and Muhammad Nasir. Forthcoming, 2023. “Poverty
Projections For Pakistan: Inflation Inequality and Sectoral Growth In Nowcasting And Forecasting.”

BISP. 21 March 2023. Press Release, https://www.bisp.gov.pk/SiteImage/Misc/files/21-3-23.pdf

Caruso, German Daniel, Leonardo Lucchetti, Eduardo A. Malasquez, Thiago Scot, and Raul Castaneda. 2017. “But?
What is the Poverty Rate Today? Testing Poverty Nowcasting Methods in Latin America and the
Caribbean.” World Bank Policy Research Working Paper No. 8104.

Federal Board of Revenue. 2020. Tax Expenditure Report 2020. Government of Pakistan.

Gaspar, Viktor, Laura Jaramillo, and Phillippe Wingender. 2016. Tax Capacity and Growth: Is there a Tipping Point? IMF
Working Paper 16/234.

IMF. 2019. Redesigning Pakistan’s Tax System. Fiscal Affairs Department Technical Report.

IMF. 2022. World Economic Outlook, April 2022.

IMF. June 2023. Staff Report for Stand-By Arrangement.

Khan, Adnan Q., Asim I. Khwaja, and Benjamin A. Olken. 2016. “Tax Farming Redux: Experimental Evidence on
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Khan, Adnan Q., Asim I. Khwaja, and Benjamin A. Olken. 2019. “Making Moves Matter: Experimental Evidence
on Incentivizing Bureaucrats through Performance-based Postings.” American Economic Review 109 (1): 237–
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Ministry of Finance. 2023a. Monthly Economic Update & Outlook: July 2023. Government of Pakistan.

Ministry of Finance. 2023b. Pakistan Economic Survey FY2022–23. Government of Pakistan.

Ministry of Finance. 2023c. Public Debt Bulletin: July-Dec 2022. Government of Pakistan.
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Nasim, A. 2012. “Agricultural Income Taxation: Estimation of the Revenue Potential in Punjab.” Pakistan
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State Bank of Pakistan. 2022a. Annual Report 2021–22.

State Bank of Pakistan. 2022b. Circular No. 13. https://www.sbp.org.pk/smefd/circulars/2022/C13.htm

State Bank of Pakistan. 2023a. Consumer Confidence Survey: July 2023.

State Bank of Pakistan. 2023b. “Credits/Loans Classified by Borrowers.”

https://www.sbp.org.pk/ecodata/CreditLoans.pdf

State Bank of Pakistan. 2023c Statistics of the Banking System. https://www.sbp.org.pk/ecodata/fsi/qc/2023/Mar.pdf

State Bank of Pakistan. 2023d. The State of Pakistan’s Economy: Half Year Report 2022–2023.

Ul Haque, Nadeem, Hanid Mukhtar, Nohman Ishtiaq, and John Gray. 2020. Doing Development Better. Pakistan
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United Nations Committee of International Experts on International Cooperation in Tax Matters. 2018. The Role of
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World Bank. 2017. “Annual Report 2016–17. Sindh Annex 6 – Property Tax Study.” Multi Donor Trust Fund for
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Annex

Annex 2.1

The latest official poverty rates available are for FY19, which was the year of the last HIES. Since then, Pakistan
has undergone several major crises, including the global COVID-19 pandemic, the devastating floods in 2022, and
a macroeconomic crisis made more precarious by increased political uncertainty. It is expected that these shocks
had a profound impact on household welfare and poverty rates in the country, but recent survey data is not available
to quantify these. In this context, welfare levels for Pakistan can be estimated using a micro simulation tool that
models the path of household welfare based on macroeconomic indicators. The underlying assumption for this
approach is that macroeconomic indicators, such as sectoral GDP growth, inflation, and changes in the real value
of private and public transfers, directly influence households’ real labor and non-labor incomes, which in turn has
a direct bearing on consumption levels and poverty.67

World Bank poverty projections come from a model that is based on the 2018–19 HIES data and projects each
household’s consumption over time by simulating the evolution of real labor and non-labor income. The resulting
consumption distribution is then used to produce poverty projections for FY20–25. More specifically, labor income
is modeled using the real growth rates of 11 sectors of the economy in which members of each household work.
That is, each household member’s projected income is computed by applying the growth rate of the relevant sector
to their income at baseline. Then, total labor income is calculated as a sum of all household members’ projected
incomes, weighted by their total contribution to that income component. For non-labor income, remittances and
private transfers are assumed to have constant purchasing power over time, whereas public transfers are modeled
after BISP payouts, which have stayed constant in nominal terms until very recently. Lastly, monthly CPI inflation
rates are used to produce real consumption projections.

Using the 2018–19 baseline, the model projects monthly household consumption. Poverty headcount is then
computed using the global lower-middle-income poverty line (US$3.65/day 2017 PPP per capita). The projected
poverty headcount rates are outlined in Table A2.1.

Table A2.1: Projected Poverty Headcount

(Percent)
FY19 FY20 FY21 FY22 FY23 FY24 FY25
(baseline) (nowcast)
Poverty headcount 39.8 42.7 38.5 34.2 39.4 37.2 35.0

67 For more details, see Caruso et al. (2017); and Barriga-Cabanillas et al. (2023, forthcoming).

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