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The FY25 Budget proposals are the initial steps to broaden the tax base in Pakistan (tax to GDP is still a paltry 9%). It raises taxes on some key agriculture inputs (DAP fertiliser and tractors), strives to encourage tax filing, and does attempt to tax retailers and real estate, albeit with question marks over sustainability.

The Budget removes a concessionary tax regime for the exporters (barring the services export industry e.g. IT) and introduces hefty punitive measures for non-tax filers, including a restriction on foreign travel.

The key positive from the market’s standpoint is that the feared sharp increase in CGT on securities did not come through. The Budget has made CGT uniform for tax filers at 15%, but hikes to as high as 45% for non-filers. The market is likely to react positively to this.

The tax on exporters has been termed a negative. Business/ trade associations have taken sharp exception to this and significant pushback from them is anticipated to persuade the government to reverse this.

The budget proposals target a 40% increase in tax revenue. Achievement of targets depends a lot on how well the government is able to manage the pushback from exporters/ retailers.

If enforceability is an issue, then the IMF may demand additional tax measures before the Budget is passed in parliament, or there could be a mini-budget by mid-year to fill any potential shortfall in tax collection.

An even higher petroleum development levy (PDL) and cuts in the development expenditure, as in the past few years, have become very likely as well.

If the IMF accepts the budget at face value, it may be enough to secure the IMF program. In part, this may be because of the clear thrust to go after non-tax filers and some effort to bring retailers/ real estate into the tax net.

However, the IMF may wait to see the final approved budget first and there may yet be changes given the PPP’s show of reluctance ahead of the budget presentation.

The presentation of the FY25 budget was in line with IMF requirements that could pave the way for a new extended fund facility and thus help cement the macroeconomic stability achieved in the last two years.

However, meeting aggressive taxation measures and generating significantly high provincial surpluses during a period of moderate economic growth seems challenging for the government. Moreover, the normalisation of income tax on exporters would hurt the future export plans of various companies.

The budget is neutral for the overall market, as a Capital Gains Tax (CGT) of 15% on purchases from July 2024 onward is imposed at a flat rate, given the holding period of less than one year for the majority of retail and high-net-worth (HNW) investors. An increase in taxation rate on dividend income derived from debt securities of mutual funds is slightly positive for the market. Moreover, there is no significant change in the factors affecting the top three sectors of the Pakistan Stock Exchange (PSX).

However, the removal of exporters from the final tax regime of 1% turnover tax is a material negative for the textile sector and some players in the steel sector.

The government has set an aggressive tax revenue increase target of 40% in the context of a nominal GDP growth of 17% for FY25. This appears to be an uphill task despite unprecedented revenue measures and the government’s ambition to digitalize the taxation system, especially following doubts about the success of the track-and-trace  system. Moreover, the enhanced reliance on provincial surpluses to achieve the fiscal deficit target of 5.9% also seems challenging. Additionally, the super tax has been maintained at previous rates to meet the ambitious revenue target.

Against the historical precedent of raising revenue through indirect taxes, the government has attempted to increase reliance on direct taxes. To achieve this, exporters, except for those in IT services, are now taxed at normal corporate tax rates. Additionally, salary and personal income tax rates have been increased, and the current slabs have been modified. Further support is provided by increasing indirect taxes, removing sales tax exemptions for various sectors, and raising customs and regulatory duties.

Markup payments are estimated to be slightly lower than Net Federal Receipts. The largest component of current expenditures is debt servicing, which is set at PKR9.8 trillion, slightly below the Federal Government’s net receipts of PKR10.4 trillion, but 18.4% higher than last year. This increase in debt servicing underscores a major challenge for Pakistan. Any delay in implementing expenditure control measures at the Center could further escalate current expenditures. Defense spending is projected at PKR2.1 trillion, while subsidies are budgeted at PKR1.4 trillion, about 27.2% higher than the revised FY24 projections.

Record development outlay targeted, the Federal Public Sector Development Program (PSDP) at a record PKR1.5 trillion, including PKR100 billion for PPP projects, a 101% increase from the revised FY24 budget. Despite fiscal constraints, this development outlay demonstrates the government’s intention to enhancing infrastructure and addressing challenges in transportation, energy, and water resources with 81% of the allocation towards existing projects. However, any reduction in revenue or increase in expenditure could dent the actual spending target.

PSX — winners and losers

The budget stands as moderately positive for cement and construction materials as well, with a significantly higher Federal PSDP allocation of PKR1.5 trillion set for the coming year, despite the extension of GST and income tax exemptions in the FATA/PATA regions. However, the announced budget stands as substantially negative for exporters, who have now been transferred to the Normal Tax Regime from the previous final tax of 1% of revenues. This change is expected to adversely affect several export-heavy companies (excluding IT-related companies), including those in the textiles sector, PABC, and MUGHAL, among others. Finally, the budget stood neutral for OMCs (higher PDL allocation is negative; GST exemption is neutral) and Banks.