Author: Ibraheem Sohail

Islamabad has managed to repay Rs2.03 trillion in the first half of the ongoing fiscal year as compared to borrowing a staggering Rs2.875 trillion in the same period of fiscal year (FY) 2023-24, the State Bank of Pakistan (SBP) has revealed.

As per the details, the federal government’s borrowings from financial institutions remained negative for the first two quarters of FY2024-25 as Islamabad was able to retire its debt liabilities owing to the record-breaking inflows the SBP was able to generate in the pervious year.

The SBP was able to generate a whopping Rs3.4 trillion in profit, as a result of stable value of the rupee in the past year along with sky-high interest rates at 22 percent.

The SBP transferred 80 percent of its profits to Islamabad, which amounted to Rs2.72 trillion. However, it might not be possible for the SBP to sustain such a high level of profitability as interest rates have been slashed to just 13 percent now.

Experts, however, predict a fall in the liquidity of the national exchequer in the upcoming half of ongoing fiscal year, which could force Islamabad to borrow funds to finance the budget. The drop in liquidity is primarily due to the fact that SBP profits are projected to fall.

According to reports, the SBP has been the government’s biggest profit-earner, surpassing any potential earnings from trade or industry. This means that cash inflows to the federal government might fall drastically in case of a drop in SBP profits.

This fall in inflows might be exacerbated by a projected fall in Treasury bill (T-bill) yields causing further liquidity issues for the government in the upcoming half.

While the retirement of debt in the first half of the fiscal year is a success, the same is being seen as temporary due to projected decline in inflows, which could prompt Islamabad to resort back to its historical trend of borrowing money for budgetary support.

As of now, the Federal Board of Revenue (FBR) has consistently missed its collection targets in the first five months of FY2024-25. Since the FBR has been unable to generate the revenues necessary to sustain budget outlays for the second half.

While current situation suggests that Islamabad will resort to utilising borrowed funds to plug the gap in the budget, speculations regarding the government’s future course of action are on the rise after achieving this short-term victory.

Officials from the International Monetary Fund (IMF) are especially interested in the unveiling of said plans given how Islamabad is not delivering on all of the agreed upon terms for the $7 billion loan that it secured earlier this year.

The Central Chairman of the Kissan Ittehad threatened to launch a march on Islamabad if the demands of farmers were not met. Farmer demands include increasing the wheat support price in addition to subsidizing input costs as they have risen recently.

The demands are not entirely baseless, as rising electricity costs have hampered the ability of farmers to cost-effectively operate tube wells for irrigation. Farmers who have access to a flowing source of water are not faring much better either, as the rate of irrigation water has increased, making it tougher for farmers to afford to irrigate their fields.

More concerningly, the prices of urea fertilizer, which is a major input in crop cultivation, have risen too. However, Islamabad’s hands are effectively tied due to the conditions imposed on the federal government by the International Monetary Fund (IMF).

Under IMF conditions, Islamabad is unable to extend subsidies to these farmers to assist them when they need them. According to the chairman of Kissan Ittehad, this could leave them open to exploitation by flour mills that can purchase wheat at below-market prices.

The implications for businesses operating in the agricultural sector will be serious if they are unable to secure governmental support in the form of minimum support prices or subsidies.

This is because rising input costs will translate directly into a fall in the profit margins of farmers. This could result in a fall in the supply of crops such as wheat and sugarcane. While the damage ends here for farm owners and the 36.43 percent of Pakistanis who call the agricultural sector their source of income, the same cannot be said for others.

It is to be noted that wheat, sugar, and other agricultural sector outputs are essential for businesses further along the supply chain. A lower supply means the prices for these inputs will rise, causing businesses that use wheat or sugar to lose profits. This spells bad news for businesses such as bakeries and confectionary manufacturers.

Islamabad is expected to feel the impact of not providing subsidies as well. Experts predict that a reduction in wheat and sugarcane yields is likely to worsen the trade deficit for Pakistan as wheat imports surged to one billion dollars in FY 2023-24.

Sugar exports brought in $330 million in 2023, and a fall in production might negatively impact export figures. The resulting widening of the trade deficit will strain the already meagre $16.62 billion in foreign reserves that the State Bank of Pakistan (SBP) possesses.

If the farmers decide that Islamabad has left them to fend for themselves, the Kissan Ittehad might deliver on its promise to ‘initiate a sit-in in the capital’. The protests will negatively impact Pakistan’s attractiveness as a stable destination for both foreign and local investment funds.

Foreign investors are disinvesting in Pakistan’s Treasury bills (T-bills) as returns have been shrinking steadily over the past few months. The returns on T-bills have been declining as The State Bank of Pakistan (SBP) has been slashing interest rates.

Interest rates reached a staggering 22 per cent last year as the SBP desperately tried to control the ever-rising inflation rate. However, with inflation rates sitting at a comfortable 4.9 per cent, the SBP has cut back its policy rate to 13 per cent. This has resulted in a nine per cent fall in the returns to T-bill holders.

Foreign investors purchased a large volume of T-bills when interest rates were high, bringing millions of dollars into Pakistan. As per Dawn News, however, the falling interest rates have resulted in foreign investors withdrawing 64 per cent of their investments from Pakistani T-bills.

The cumulative outflows from T-bills stood at 550 million dollars, which will undoubtedly ring alarm bells in Islamabad. The government cannot credibly rely on T-bills to fund the federal budget if investors choose to withdraw their money in such large volumes.

With investors unwilling to buy T-bills, the possible measures taken by Islamabad to plug the gap between expenditures and inflows in the federal budget might cause issues for businesses. Business owners could face the consequences in the form of higher taxation as the government might find itself strapped for cash.

More concerningly, the government might resort to borrowing funds from local banks, which could crowd out private investments. This is because the private sector might not be able to secure loans if the government is borrowing vast amounts of funds from local banks.

Rising taxes could reduce profit margins for businesses, while a decline in the availability of credit might hurt business growth as businesses will be unable to secure funds to expand their operations.

The rupee might experience devaluation, with foreign investors finding alternative destinations for their funds where returns are higher than those of Pakistan. A weaker rupee is unable to procure a high level of imports. While this does reduce the trade deficit, which Islamabad can hail as a victory, it spells bad news for manufacturers who rely on imported goods to produce final goods.

The declining value of the rupee for these manufacturers translates into lower profit margins as their input costs have risen. These business owners will have to make the tough choice of either passing on the higher costs to customers to maintain their profit margins or absorbing the higher prices, reducing profitability instead.

While falling interest rates have reduced rates, the SBP and the Government of Pakistan could still take steps to reduce T-bill outflows. Authorities could ease restrictions on the repatriation of T-bill returns in order to incentivise foreign investors to reinvest once their T-bills mature.

Moreover, attempting to increase political stability will portray Pakistan as a low-risk destination for foreign funds. As it stands, though, Islamabad is making an active effort to reinstate political stability as talks with Pakistan Tehreek-e-Insaaf (PTI) have begun.

Outflows from T-bills of such a large magnitude are concerning, and it will be interesting to see what the SBP does now to counteract these rising outflows.

A global poll conducted by AccaGlobal to survey if citizens agree that taxes are paid in exchange for services, has displayed shocking results. As per the details, the poll suggested that just one-third of the population sees the social contract of taxation to be a deal that works in practice.

Taxes are levied on the general public to provide public goods that everyone can utilise. Popular examples of public goods financed by taxation are toll free roads, public hospitals and public schools.

Every individual has equal access to public goods and services, and cannot be excluded from utilising them. In line with this thinking, 52 percent of poll respondents felt that taxes were a contribution to the community rather than a cost.

Poll respondents believed that public goods and services were a necessity. However, 25 percent disagreed, stating that in their opinion, taxes were a cost and not a contribution to the community.

It is to be noted that only 33 percent of poll respondents believed that tax revenues collected in their country were actually used to provide public good while 46 percent outright refute this belief.

There are two possible reasons as to why respondents believe their tax funds are not spent on them. The first of these is the level of corruption within the country. This could indicate that taxpayer funds are being misused as government officials consider said funds to be a source that can be used to illegally enrich themselves.

The second reason concerns only the elite. This is because as wealth rises, it is unlikely that an individual would be a consumer of public goods and services. An example here could be a wealthy individual choosing to seek care at a private hospital as opposed to a local public hospital.

Since both of these segments of society do not expect the funds to be spent on them, they believe that their funds never actually serve them.

Poll respondents from Latin America displayed the most amount of pessimism regarding their tax funds being allocated to services they need. This makes sense as countries like Brazil and Argentina score abysmally low on the corruption index with scores as low as 36 out of 100 – the lower the score, the more rampant corruption is in the country.

The chief executive of AccaGlobal has highlighted how public trust in taxation systems is necessary for an economy to attain prosperity. These arguments can also be applied to Pakistan as higher transparency and lower corruption levels might boost tax levels, resulting in citizens believing that their funds are truly spent on them.

International lenders have grown worried over Khyber Pakhtunkhwa’s rising debt levels as it surged by 28 percent in just a year. As per Dawn, the outstanding debt KP is liable to pay stands at a staggering 680 billion rupees.

While this might not seem alarming at first glance, financial experts are predicting a drop in the development potential of KP as risk indicators continue to worsen in the province. As it stands, the provincial government of KP has been alerted by international creditors regarding the potential solvency issues that the government might run into.

In a meeting with KP leadership, international lenders suggested a solution- austerity measures.

As per Dawn News, the reason KP finds itself in constant need to borrow funds is because of PTI leadership’s focus on political issues rather than the economy. The claim has some merit to it as constant rallies to Islamabad and protests cause members of the provincial assembly to leave Peshawar largely unattended. This has created a vacuum for guidance within the decision makers, especially regarding matters pertaining to the economy.

The rising debt burden comes at an inconvenient time as IMF expects budget surpluses of large magnitudes from both the provincial and federal government. The IMF condition in reference here requires all four provincial governments to generate a budget surplus of 1.127 trillion rupees.

However, with KP relying on debt to finance government expenditures, lawmakers in Islamabad are worrying that the third largest provincial economy within the country may not be able to record a sizable budget surplus to meet IMF requirements.

This is largely due to the fact that in the coming months, the burden of interest payments is expected to rise. For businesses across the province, this spells bad news as the government might try to levy additional taxes or try to expand the tax net in an attempt to meet IMF guidelines.

The sectors where KP might attempt to increase tax collection will most probably be agriculture, automobiles, services, property and stamps. The reasoning behind this is that provinces are allowed to collect taxes on activity from these sectors.

For the upcoming fiscal year 2024-25, KP has budgeted a staggering 67 billion rupees for debt payments. Of this total amount, over 40 percent will be purely to pay back interest on the principle amount.

The interest repayments reduce KP’s ability to fund public projects within the province as the government will cut back expenditure on projects to pay back interest instead. The loss of potential public development initiatives is alarming as the current unemployment rate in KP stands at an uneasy eight percent which may rise even further if the government starts shelving projects as part of the stipulated austerity measures of the IMF.