Challenges for the next budget

“Pakistan approaches its next federal budget not with optimism, but under the weight of numbers that have grown more unforgiving since the original assessment. Between July 2025 and February 2026 alone, the federal government’s debt rose by a staggering Rs1.99 trillion to Rs79.9tr, including external debt equivalent of Rs23.2tr, according to the State Bank of Pakistan. The International Monetary Fund (IMF), in its April 2026 Fiscal Monitor, estimated gross government debt at 70.1pc of GDP for the current fiscal year. More alarming still, debt servicing continues to devour an estimated 50pc or more of total revenues. During the first half of the year, interest payments on public debt reached Rs3.56tr — more than double the combined allocations for defence and the Public Sector Development Programme. This is no longer just a budgetary imbalance; it is structural captivity, where the past dictates the future. This reality is further complicated by binding commitments under the IMF’s $7 billion programme, where disbursements are now tied to time-bound structural reforms. The fiscal framework is no longer purely domestic — it is externally anchored, with policy direction increasingly shaped by compliance milestones rather than discretionary priorities. Any attempt to introduce new taxes or reduce subsidies will face stiff opposition, yet failure to do so risks losing IMF support The fiscal deficit, while projected to improve, remains a high-wire act. The IMF projects Pakistan’s fiscal deficit at 3.2pc of GDP during the current fiscal year and next — down from 5.4pc in FY25. Yet the Fund’s own medium-term outlook is deeply troubling: it forecasts the deficit rising again to 3.6pc of GDP in FY30 and further to 4.6pc in FY31. T The primary surplus, a key IMF metric, has remained strong equivalent to 3.2pc of GDP in the first half of FY26. But the IMF expects this surplus to decline to 2pc of GDP next year and then drop sharply to just 1pc by FY30 and a negligible 0.1pc by FY31. This is not sustainable consolidation; it is borrowed time. On the growth front, the ongoing Middle East conflict, which erupted in late February, has dealt a severe blow to recovery prospects, threatening to slow growth in the next fiscal year through higher energy and fertiliser costs, weakening agricultural and industrial output, reducing remittances, and widening the current account deficit. Inflation, which had cooled significantly, is now poised to rise again. The Asian Development Bank projects average inflation at 6.4pc in FY26 and 6.5pc in FY27, driven by surging global oil prices and disrupted trade routes. The IMF’s projections are even more alarming: 7.2pc for the current year, rising to 8.4pc in 2027. The Consumer Price Index had already risen to 7.3pc in March 2026. This resurgence will erode purchasing power and complicate the central bank’s monetary policy stance — particularly as energy pricing reforms under the IMF framework continue to pass through to consumers. Defence spending, shaped by an increasingly volatile geopolitical environment, continues to rise. The government allocated Rs2.55tr for defence in the FY26 budget, a nearly 20pc increase from the previous year, equivalent to approximately 2pc of GDP. This does not include pensions for retired military personnel. Every additional rupee allocated to defence must be matched by greater efficiency elsewhere, or the imbalance will deepen. Energy reform remains at the centre of Pakistan’s fiscal future, but progress has been painfully slow. The power sector’s circular debt currently stands at approximately Rs1.9tr, with the government aiming to reduce it to Rs1.61tr by June 30. However, a refinancing plan has been shelved after failing to secure concessional financing from international lenders and Saudi Arabia. The gas sector is in even worse shape, with circular debt jumping to over Rs3.4tr. Without resolving circular debt, improving distribution efficiency, and investing in sustainable energy, the budget will remain a temporary arrangement — not a lasting solution. The IMF’s Extended Fund Facility remains the central anchor of Pakistan’s economic policy, but the relationship is increasingly strained. The Fund is pushing for an ambitious tax target of Rs15.6tr for FY26–27, tied to a tax-to-GDP ratio of 11.3pc. However, Pakistani officials maintain that 10.7pc is a more realistic benchmark. The FBR’s tax-to-GDP ratio currently stands around 10.6pc, significantly below the estimated potential of 15pc. Simultaneously, trade policy is shifting, with commitments to phase out non-tariff barriers on imports — risking increased import volumes and renewed pressure on foreign exchange reserves unless matched by stronger export performance. The government is caught between the IMF’s stringent demands and the domestic imperative to provide relief to a population already strained by inflation and unemployment. Recent shocks have deepened this challenge. An assessment by the International Labour Organisation estimates that the 2025 floods affected around 3.3 million jobs, particularly in agriculture, livestock, and informal sectors. Expanding social protection through programmes like the Benazir Income Support Programme has become not just a welfare measure but an economic necessity. The government’s room for manoeuvre is extremely limited. Any attempt to introduce new taxes or reduce subsidies will face stiff political opposition, yet failure to do so risks losing IMF support and destabilising the external account. This is the fundamental dilemma at the heart of the next budget. In the end, the new budget will be judged not by its arithmetic alone, but by its elemental courage. Pakistan has achieved a measure of hard-won stability — the State Bank’s foreign exchange reserves have strengthened to $15.1bn (as of April 17) and are projected to climb to $18 billion by June 2026. But this stability is fragile, threatened by external shocks and internal constraints alike. Published in Dawn, The Business and Finance Weekly, April 27th, 2026

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