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Debt servicing consumes 69% of revenue while development spending stays compressed
ISLAMABAD:
The federal budget for FY 2026-27 arrives at a moment of relative macroeconomic calm, but not yet economic confidence. Pakistan has moved away from the crisis conditions of 2022-23: inflation has eased, reserves have improved, and the current account deficit has been tamed. Yet the recovery remains fragile, dependent on external financing, fiscal discipline and implementation of the International Monetary Fund (IMF) programme. This is not a growth budget. It is a consolidation budget, designed to reassure lenders more than to re-energise the economy.
The central policy anchor is fiscal restraint. The government projects nominal GDP at Rs143.6 trillion, real growth of around 4%, average inflation of 8.2%, an overall fiscal deficit of 2.9% of GDP and a primary surplus of 2%. These numbers are broadly consistent with the IMF framework, but rest on demanding assumptions. The key one is the Federal Board of Revenue (FBR) target of Rs15.264 trillion, a 17.5% revenue increase over the revised estimate for FY 2025-26. Since the outgoing year’s original FBR target was missed by over Rs1.1 trillion, the new target is ambitious, if not optimistic.
The budget continues Pakistan’s reliance on taxing those already within the system. Direct and indirect taxes appear almost equal on paper, but direct taxation remains heavily dependent on withholding taxes, which often function as transaction levies rather than genuine income taxation. Sales tax, customs and federal excise remain central to revenue mobilisation, placing a disproportionate burden on consumers and formal businesses. The unchanged 18% GST rate reinforces the regressive structure of the tax system.
There are positive measures. It is a relief to see the personal income tax surcharge gone. Reduction in corporate super tax and slab adjustments for the salaried class are welcome. Under the National Tariff Policy, reducing additional customs duties and rationalising regulatory duties can lower input costs, improve competitiveness and support exporters. The extension of favourable treatment for IT exporters, abolition of deemed income tax on immovable property, removal of taxes on sanitary pads, and exemptions for agricultural machinery and critical medicines are also welcome. These measures may not transform the economy, but they move in the right direction.
On expenditure, the real story is debt servicing. Interest payments are budgeted at Rs8.054 trillion, consuming nearly 69% of the net federal revenue. This explains why there is little room for development spending, social investment or tax relief. Even if interest costs moderate, the structure of domestic debt leaves the government exposed to rollover and rate risks. Without primary surpluses, debt management reforms and deeper domestic capital markets, fiscal space will remain trapped by past borrowing.
Development spending is another weak point. The federal Public Sector Development Programme (PSDP) is maintained at Rs1 trillion, while the national PSDP is lower than the previous budget estimate. Water sector allocations have increased, which is sensible given Pakistan’s climate vulnerability. But overall development expenditure remains compressed, making choices in this constrained environment critical. A country cannot achieve sustained growth by financing consumption, subsidies and debt servicing while postponing investment in productivity, skills, infrastructure and resilience. The reduction in climate mitigation allocations is troubling alongside new climate-linked levies and continued taxation of green technologies.
The budget also depends heavily on provinces. Transfers under the National Finance Commission (NFC) Award are projected at Rs8.848 trillion, while the fiscal deficit target assumes a provincial surplus of Rs1.794 trillion. If provinces spend more than expected, or if revenue falls short, the deficit could widen quickly. Pakistan needs mature fiscal federalism in which federal and provincial governments jointly commit to tax effort, expenditure quality and development outcomes. The absence of a new NFC Award weakens this conversation.
Social protection remains necessary. The allocation for the Benazir Income Support Programme (BISP) is substantial, at around Rs845 billion, and rightly protects vulnerable households from the adjustment burden. But concentration almost entirely in cash transfers exposes gaps. Pakistan needs broader protection for informal workers, disaster-affected communities, persons with disabilities, children and small farmers facing climate shocks. Cash transfers are essential, but cannot substitute for comprehensive social policy.
In political economy terms, the budget offers incremental reform without a decisive break from the past. It reduces some distortions, rationalises income tax rates and protects the IMF path. But it continues to lean on petroleum levies, withholding taxes, indirect taxation and optimistic revenue assumptions, while lacking a comprehensive strategy for investment, exports, productivity and jobs.
The lesson is clear: Pakistan has learned how to prepare budgets that satisfy short-term financing conditions. It has not yet learned how to prepare budgets that expand productive capacity. Fiscal consolidation is necessary, but not sufficient. The next stage must reform the tax base, expenditure quality, debt structure, energy sector and public investment process. Budget 2026-27 should therefore be read as a holding operation. It may preserve stability, meet IMF commitments and avoid immediate slippage. But unless the government turns consolidation into competitiveness, stability into investment, and taxation into fairness, Pakistan will remain caught in adjustment without transformation.
THE WRITER IS FOUNDER AND CHIEF EXECUTIVE OF THE POLICY RESEARCH INSTITUTE OF MARKET ECONOMY