IMF imposes 11 new conditions on Pakistan after Operation Sindoor, demands PKR 17.6 trillion budget approval

The International Monetary Fund has imposed a new set of 11 conditions on Pakistan before it releases the next tranche of the USD 7 billion Extended Fund Facility, as the fallout from Operation Sindoor—India’s recent military operation targeting terror camps inside Pakistan—raises alarm over fiscal reallocation, institutional stability, and economic credibility. A staff-level report released in mid-May, as cited by Pakistani media including The Express Tribune, highlights a growing intersection between geopolitical volatility and financial discipline in South Asia’s most fragile economy.

The IMF’s latest conditionalities mark one of the strictest updates to Pakistan’s bailout framework since the facility’s revival in 2023. Although the EFF was intended to support economic reforms in the wake of pandemic-related and debt-induced economic pressures, recent escalations in cross-border tensions with India have added another layer of complexity. The Fund explicitly warned that Pakistan’s fiscal and structural reform goals are now at risk unless swift, politically sensitive measures are taken—particularly in budget approvals, energy pricing, tax collection, and defense spending.

Why Did the IMF Add New Conditions After Operation Sindoor?

The timing of the IMF’s expanded conditionalities comes just days after India’s Operation Sindoor, which targeted multiple terror launchpads across Pakistan-occupied Kashmir and parts of Punjab province. While the IMF’s report refrains from overt geopolitical commentary, it indirectly acknowledges that rising regional tensions may trigger higher defense spending, foreign reserve outflows, and stalled reforms. Analysts say Pakistan’s historically high military expenditure has been a recurring concern in prior IMF negotiations, but the current surge in allocations post-Sindoor has added urgency.

According to preliminary disclosures from Pakistan’s Ministry of Finance, the proposed defense budget for FY2025-26 stands at PKR 2.414 trillion, up 12% from the previous year. However, internal government discussions—cited in Business Today—suggest that total military allocations may surpass PKR 2.5 trillion, representing an 18% rise. The IMF flagged this as a key fiscal risk, especially if such spending leads to cuts in social programs or delays in tax reforms. The report also highlighted the need for fiscal space to remain directed towards long-term stability rather than reactionary defense posture realignments.

What Are the 11 IMF Conditions Now Required for the Next Bailout Tranche?

At the core of the new IMF benchmarks is a requirement for the Pakistani Parliament to pass a PKR 17.6 trillion federal budget for FY2025-26. This is among the largest fiscal outlays in the country’s history and includes PKR 1.07 trillion earmarked for development spending. Interest servicing, however, continues to dominate Pakistan’s budget, with PKR 8.7 trillion allocated just for debt repayments. The IMF expects Pakistan to run a primary budget surplus of PKR 2.1 trillion but forecasts a consolidated fiscal deficit of PKR 6.6 trillion, raising concerns over funding sustainability.

Energy sector reforms also form a major pillar of the new conditionalities. The IMF requires the removal of the PKR 3.21 per unit cap on debt servicing surcharges embedded within electricity bills by June 30, 2025. Furthermore, electricity tariffs must be rebased annually starting July 1, and gas prices must be adjusted semi-annually with the next revision due by February 15, 2026. These price adjustments are intended to bring Pakistan’s power and gas sectors to cost-recovery levels and curb the ballooning circular debt, which stands above PKR 2.7 trillion according to the latest estimates from the Energy Ministry.

Tax reforms were also reinforced, particularly the long-delayed agricultural income tax, which the IMF says must be uniformly implemented across all provinces. Provincial governments are expected to create taxpayer identification platforms, issue tax notices, and develop compliance plans by June 2025. This demand, long resisted by powerful feudal lobbies, is now being framed by the IMF as essential to fair taxation and sustainable revenue generation.

Trade liberalization constitutes another structural demand. The IMF directed Pakistan to lift its restrictions on the import of used cars older than three years. By the end of July 2025, Islamabad must table legislation allowing the import of vehicles up to five years old. The IMF argues that relaxing import age limits would improve affordability, increase competition in the domestic auto market, and reduce the fiscal burden created by excessive import controls.

In addition, the Fund has asked the Pakistani government to finalize and publicly release a Governance Action Plan, derived from its 2024 Governance Diagnostic Assessment. This document is intended to address institutional corruption, procurement opacity, and accountability deficiencies across ministries and public enterprises. The government has committed to publishing the plan in the upcoming fiscal cycle.

How Has Pakistan Responded to the IMF’s New Conditions?

Pakistan’s Ministry of Finance has not officially disputed any of the IMF’s latest demands, but government officials privately acknowledge the political cost of implementing such reforms—particularly energy tariff hikes and tax broadening measures. The ruling coalition, already facing growing dissent ahead of general elections, is reportedly weighing the social impact of these reforms against the consequences of a suspended IMF facility.

Public reaction has also been critical. Utility costs for the average household have more than doubled over the past two years, and new surcharges threaten to deepen the cost-of-living crisis. Protests have broken out in Karachi and Lahore over anticipated tariff hikes, and agricultural associations have pushed back on proposed income tax expansions.

Meanwhile, the government’s maneuvering room is constrained by low foreign exchange reserves, which stand at just USD 9.2 billion as of mid-May 2025—barely enough to cover eight weeks of imports. The Pakistani rupee continues to face downward pressure, trading at around PKR 311 per U.S. dollar, with further depreciation expected if IMF disbursements are delayed.

What Does the IMF Say About the Risks Ahead?

The IMF’s staff-level assessment underscores three main risks: geopolitical instability, policy slippage, and social backlash. While Pakistan’s commitment to the EFF remains formally intact, the IMF has noted persistent delays in prior structural benchmarks. These include missed deadlines for gas pricing reforms and governance transparency in SOEs. The Fund has now made future tranches strictly contingent on the timely delivery of each of the 11 new measures.

The IMF also pointed to the rapid expansion of defense spending post-Operation Sindoor as a fiscal red flag. If Pakistan reallocates more funding toward defense without proportionate increases in revenue or reductions elsewhere, the IMF may re-evaluate its risk-adjusted disbursement timelines. Analysts note that this is the first time the IMF has so clearly linked security developments with fiscal planning in a South Asian context.

What Is the Institutional Investor View of Pakistan After This Update?

Pakistan’s global sovereign bonds have responded with mixed signals. After the IMF’s updated conditions were reported, yields on Pakistan’s 2026 eurobonds rose to 19.7%, indicating heightened default risk priced into markets. Ratings agencies have refrained from immediate downgrades but flagged the rising fiscal deficit, defense burden, and social instability as key indicators to watch. Moody’s has maintained its Caa3 rating with a negative outlook, while S&P Global has placed Pakistan on a ratings watch with potential downgrade.

Domestically, the Karachi Stock Exchange (KSE-100) remains volatile. While select export-oriented sectors like textiles have shown resilience due to rupee depreciation, financials and consumer goods have underperformed due to rising input costs and weak demand. Foreign institutional inflows have stagnated since late April, reflecting caution around macro and security risks.

Will Pakistan Comply with IMF Demands or Risk Default?

The coming months will serve as a litmus test for Pakistan’s reform commitment. Failure to meet the 11 new conditions could freeze the next tranche, potentially triggering a sovereign credit event. On the other hand, full compliance—especially on energy and tax reforms—may secure at least USD 1.2 billion of inflows by Q3 2025 and unlock additional multilateral funding from the World Bank and Asian Development Bank.

However, compliance won’t come easy. With inflation above 24.3%, and political fragmentation growing in the wake of the Operation Sindoor fallout, the government’s ability to legislate sensitive reforms is far from certain. The IMF, in its report, emphasized that all conditionalities are non-negotiable. Any deviation could lead to a confidence collapse in international markets—something Pakistan, with external debt nearing USD 130 billion, can ill afford.