Pakistan's economic reform program, backed by the International Monetary Fund (IMF), faces significant risks due to heightened tensions with India. The IMF has recently increased the conditions attached to its bailout package for Pakistan, explicitly warning that sustained or escalating conflict with its neighbor could derail the country's fiscal, external, and reform objectives.
The IMF's concerns are outlined in its staff-level report, released on Saturday. The report acknowledges that tensions between India and Pakistan have risen considerably in recent weeks. This warning comes after India’s ‘Operation Sindoor’ in response to the Pahalgam terror attack. Pakistan allegedly responded by attempting to attack Indian military bases, leading to a brief period of intense cross-border exchanges before an understanding was reached to de-escalate.
In light of these developments, the IMF has imposed 11 new conditions on Pakistan, bringing the total to 50. These conditions are designed to ensure that Pakistan adheres to the agreed-upon reform program and achieves macroeconomic stability. Key conditions include parliamentary approval of a record Rs 17.6 trillion federal budget, an increase in the debt servicing surcharge on electricity bills, and the removal of restrictions on importing used cars older than three years.
The IMF is also pushing for reforms related to agricultural income tax, requiring provinces to operationalize platforms and enforcement mechanisms by June. Additionally, a governance action plan based on the IMF’s Diagnostic Assessment must be published to tackle systemic vulnerabilities. The Fund is also mandating a plan to phase out incentives related to Special Technology Zones and other industrial parks by 2035, with a roadmap due by the end of this year.
The report also highlights concerns about Pakistan's defense spending. While the IMF projects Pakistan's 2025-26 defense allocation at Rs 2.414 trillion, a 12% increase, the Pakistani government has indicated a potentially higher outlay exceeding Rs 2.5 trillion, reflecting an 18% increase after the recent conflict with India. This increased military expenditure could strain the government's finances and divert resources from essential development projects, further jeopardizing the IMF-backed reforms.
The IMF's apprehension is rooted in the potential economic consequences of sustained tensions or conflict. Increased military spending, disruption to trade and investment, and heightened security risks could all negatively impact Pakistan's economy. Furthermore, any perceived lack of evenhandedness or misuse of funds could create reputational risks. India has previously opposed the IMF's extension of loans to Pakistan, raising concerns that the funds could be used to finance state-sponsored cross-border terrorism.
To mitigate these risks, the IMF is urging Pakistan to prioritize de-escalation with India and focus on implementing the agreed-upon economic reforms. Pakistan must demonstrate its commitment to fiscal discipline, structural reforms, and good governance to maintain the IMF's support and ensure the success of its bailout program. The coming months will be critical in determining whether Pakistan can navigate these challenges and secure its economic future.
