While much has been said on the character of the budget, including revenue targets, growth and size of public spending, it is good to review the underlying foundations upon which these estimates have been built. While the budget has a feel-good focus on SMEs, IT sector, social spending and tax reforms, a deeper dive into the assumptions around which the budget has been built suggests that it is inflationary in nature and will likely face serious implementation challenges.

The first and foremost challenge following the budget is the uncertainty about negotiations with the International Monetary Fund. It is still unclear what stage the government’s discussions with the IMF have progressed to and where it faces a deadlock. Pakistan is already experiencing several setbacks. The World Bank (WB) and the Asian Development Bank (ADB), two of the largest lenders to the country, have deferred their approval of $1 billion worth of loans, for which, failing to meet certain loan conditions and a deadlock in discussions with the IMF, have been cited as major reasons.

This has created uncertainty around budget proposals, particularly their implementation. Whether or not the IMF agrees to the proposed budgetary measures, will have serious implications for the economy. If it does not, will the government decide to exit the programme? Pakistan’s past relationship with the IMF warrants such concerns. For now, however, an exit appears unlikely, given the serious economic repercussions of such a decision, which go far beyond mere budgetary support. An exit will affect the country’s recovery from the Covid-19 disruptions and may wipe out the stability achieved so far.

If the IMF gains a footing in negotiations and the government accepts its conditions (the more likely case), the question of how such conditions will affect budgetary targets and measures, will arise. Will a supplementary budget be announced? How will this effect electricity prices? These and other questions have created uncertainty around the budget, despite several welcome announcements. A well-read market reaction to the budget may indicate the impact of this uncertainty in the coming days. The government must take steps to clear the air around its talks with the Fund.

The second major challenge is the assumptions around which many of the budget targets have been set. First, the budget indicates an extra Rs 570 billion will come from the provinces. The amount in the previous budget was around Rs 242 billion. Receiving an additional Rs 300 billion in FY22, will be very difficult as not much has changed. Second, raising Rs 250 billion from privatisation will not only be a challenging task, but seems rather unlikely, given the country’s history on the matter. Till date, Pakistan has not been able to fully implement privatisation or control SOE losses. The proposal adds to existing pressures, as experts consider the target to be off by Rs 500 billion, when adjusted for last year’s trends, inflation and GDP growth target for FY22.

Fourth, the pro-growth policy measures laid down in the budget are likely to face serious challenges. Let’s begin with the SMEs. The sustainable and inclusive growth proposed by the finance minister will not be possible without economic inclusion of people and businesses, particularly SMEs. While the budget claims to target increasing the financial inclusion of SMEs, it does not lay out a roadmap nor offers any specific measures to achieve this transformation. Measures like opening village banks may not fully address structural barriers that SMEs face.

In addition to its traditional reluctance to lend to SMEs, the banking sector now faces an additional risk of growing bad loans extended to the SME sector during the pandemic, under SME-support measures. In fact, the banking sector fears a default on most of the loans extended to SMEs. Establishing a risk fund would have been helpful in motivating the banking sector to lend to SMEs.

The growth dividend of the budget will also depend on future energy prices. Which, in turn, depends on the outcome of IMF-government negotiations. Any hike in energy prices can compromise growth gains. The expected hike in petrol prices in order to meet the petroleum development levy (PDL) target of Rs 620 billion, will further decelerate the economy.

The fifth challenge, is the tradeoff between budget targets and inflation. The budget is inflationary in nature. Experts predict the government may have to increase petrol prices by Rs 20-25 per liter, if it is to meet the PDL revenue target. This simply means a cost-push inflation. If the IMF does not budge on its demand for energy price hikes, inflation may increase further.

Double-digit inflation during FY22 is therefore likely and may diminish the feel-good factors seen currently. People are already under an unbearable inflation burden. Higher inflation in the upcoming year will not only compromise growth targets, but may also create social unrest. If this happens, the government may be forced to choose between inflation and a budget deficit.

A lower than required raise in petroleum prices, less than expected surplus from provinces and lower collections from privatisation may inflate the budget deficit beyond the given target of 6.3 percent, possibly touching 7 percent or higher. In other words, public debt may balloon further – which happens to be the sixth challenge the government may face. According to State Bank data, Pakistan’s public debt and liabilities in March 2021 increased to Rs 45.470 trillion from 42.804 trillion in March 2020, rising to 97.4 percent of the GDP in March 2021. If the trend continues, public debt and liabilities may surpass the GDP in FY22.

According to the Budget in Brief document, the government has budgeted public debt at Rs 1,166.527 billion for FY22. This, however, may go well beyond the given figure, if history is any guide. In the outgoing year, the government increased public debt to Rs 1,517.064 billion against the budgeted Rs 1,178.886 billion. Assuming the end year fiscal deficit stands at 7.3 percent, against the 6.3 percent budgeted for FY22, an increase of 1 percentage point will create additional public debt of Rs 538.67 billion. Total public debt in FY22 will increase to Rs 1705.197 billion.

While Covid-19 related expenditures have understandably added to the debt burden, a continued rise in debt on the back of poor tax collections can disturb the government’s medium to long-term plan to manage public debt. The government had not been able to raise revenues considerably, even before Covid-19. Overall fiscal deficit in 2018-19 stood at around 9 percent of the GDP. Do not forget that nominal GDP in 2018-19 increased on the back of higher inflation, leading to a lower deficit estimate.

Similarly, in the outgoing fiscal year, revenue collection was mainly financed by an 8.6 percent inflation and a depreciation of rupee against the dollar. Experts consider around Rs 500 billion in revenue to have come from depreciation alone, with a higher rupee value of imports leading to higher tax collections.

The government must seriously work on increasing tax revenues by expanding the direct tax base. However, if the 2021 budget is any indication, it seems that the government remains more focused on raising revenue through indirect taxation. In fact, it is budgeted to collect Rs 3,647 billion from indirect taxes, with a key share worth Rs 2,506 billion coming from sales taxes. Progressive taxation remains a distant hope.

With the budget now having been presented and relatively well-received, the government must recognise these and other challenges and lay out a clear plan to overcome them. Each of these challenges, if left unaddressed, can adversely affect the government’s agenda of a sustainable higher growth level and higher economic inclusion, in addition to disturbing the budget plan.

The government must understand that sustainable and inclusive growth comes from sustainable and inclusive foundations. Effective and efficient fiscal planning to support such an agenda, is not possible without admitting the underlying challenges. In this regard, a realistic and contextual analysis is the first pre-requisite – the government needs to work on it.

The writer is an economist with interest in social content in macroeconomic policy. He regularly writes on structural issues facing the economic policy in the country. He tweets @sajidaminjaved