KARACHI (Reuters) - The government is cutting its development spending by almost half, squeezed by worsening economic conditions and International Monetary Fund demands, govt sources say, imperilling growth prospects. Pakistan will cut its Public Sector Development Programme (PSDP) budget by 46 percent to 150b rupees ($1.75b) for fiscal year 2010/11, according to govt sources who declined to be identified because they were not authorised to speak to the media. We had to cut the PSDP to reduce expenditure, especially after the floods, one source said. Failure to make the cuts, however, could endanger relations with the IMF, which loaned Pakistan $11b in 2008 to rescue an economy in free fall, because it would not be able to meet deficit targets set as a condition of the loan. Approximately $4b remains to be disbursed, and future loan programmes would depend on Pakistans commitment to reforms. The IMF and Pakistan agreed on a revised fiscal deficit target of 4.7 percent of gross domestic product in 2010/11 following the summer floods, compared with an original target of 4 percent of GDP. To hit that target, the IMF told Pakistan to raise revenue. The country has been unable to do so, however, so it has chosen to cut spending. The floods are estimated to have caused $9.7 billion in damages including vital infrastructure. The new cuts will further impact investment in roads, bridges and dams, which Pakistan needs to grow its economy. By cutting PSDP, we are not creating any assets for future generations and will have problems going forward, said Ashfaque Hasan Khan, Director General at NUST Business School in Islamabad. But theres very little fat for Pakistan to cut thanks to a past failure at reform. Its debt servicing is $5.464 billion this year, and seeking to cut the defence budget in a country still obsessed with India as a threat is a non-starter. Pakistan is really stuck between two difficult choices, but first and foremost, the cut in PSDP is because there is pressure to meet a certain fiscal deficit target, said Khalid Iqbal Siddiqui, Director at Invest and Finance Securities Ltd. And since PSDP is the one expense which is 'flexible, it is easy to cut down. Pakistans economic growth which averaged above 7 percent per year since 2000/01, declined to 5.8 percent in fiscal year 2007/08. Thanks to the floods, it is now expected to grow by just 2.5 percent in the year ending June 30. Pakistan is heavily dependent on foreign aid and must show its commitment to fiscal reforms such as raising electricity tariffs, implementing a reformed general sales tax (RGST) and restructuring its energy sector if it wants more assistance. Under the headline Reform or else, an editorial in the liberal weekly newspaper, the Friday Times, suggested a progressive income tax on agriculture a source of many lawmakers wealth and a uniform VAT on goods and services. Govt spending on big ticket weapon systems like F-16s would have to end, it says, and the military would need to realise that an unstable economy is more of a threat than India. Will it happen? the editorial asks. The record is depressing. But in view of the disparate, rising threats of the future, we have run out of options.