Positive fiscal outcome of 2025-26

The information on fiscal operations in Pakistan in 2025-26 was released last week by the Federal Ministry of Finance, both of the Federal and the Provincial Governments.

The numbers indicate a spectacular success in containing the size of the consolidated fiscal deficit, which is the aggregation of the Federal budget deficit and the Provincial cash surplus. The budget deficit is down to the unbelievably low level of 2.6 percent of the GDP in 2025-26. This is the lowest deficit as a percentage of a deficit since 2003-04, when it stood at 2.9 percent of the GDP. There have been years afterwards when the deficit rose to above 7 percent of the GDP.

The performance is also exceptional in relation to the targeted deficit for 2025-26. This was 5.1 percent of the GDP. As such, a big deficit reduction of 2.5 percent of the GDP has been achieved in relation to the target. Further, it is a very sizeable reduction in relation to the consolidated budget in 2024-25 of 5.4 percent of the GDP.

There is need to identify if this is a once-and-for-all positive outcome or if it is a sustainable improvement. The answer rests on the size of the targeted budget deficit for 2026-27. The magnitude is 3.6 percent of the GDP. Therefore, a 1 percent of the GDP increase is anticipated in the budget deficit in 2026-27. It will not be possible to sustain the budget deficit in 2026-27 at the record low level in 2025-26.

The fundamental question is how the deficit reduction of 2.5 percent of the GDP in relation to the target deficit of 5.1 percent of the GDP was achieved? The answer will also indicate the extent of sustainability of the big improvement in the budgetary position.

The absolute magnitude of the deficit reduction in 2025-26 in relation to the level in 2024-25 is Rs 2,855 billion. A number of factors appear to have contributed to this reduction. The first factor is the rise in the level of net federal revenues, after the NFC transfer to the Provincial Governments, of Rs 573 billion. This explains 20 percent of the reduction in the size of the budget deficit.

The next major factor is the big decrease in the absolute level of federal expenditures. This is the real area of success in 2025-26, with a reduction in federal expenditure of as much as Rs 1,754 billion, contributing 61 percent to the deficit reduction.

The major contributor to this expenditure saving is the Rs 1,217 billion fall in the cost of debt servicing. The budgeted amount of debt servicing for 2025-26 was Rs 8,207 billion. The actual amount is Rs 6,947 billion, lower by as much as Rs 1260 billion. The question is how this quantum reduction was achieved when there was actually an increase in the SBP policy rate by 1 percent over the year?

There has also been a cut in development expenditure in relation to the actual level in 2024-25 of Rs 281 billion, and in relation to the budget estimate by Rs 154 million. The third source is the negative statistical discrepancy of Rs 853 billion, compared to Rs 328 billion in 2024-25.

The fourth source of reduction in the overall budget deficit is the size of the provincial cash surplus, which is higher by Rs 528 billion in relation to the level in 2024-25.

As highlighted above, the issue is the sustainability of these improvements in 2026-27. The first observation is that the targeted deficit has been raised from 2.6 percent of the GDP to3.6 percent of the GDP in 2026-27.

The quantum reduction in the debt servicing by Rs 1,217 billion in 2025-26 is not being sustained. Instead, it is expected to rise by as much as Rs 1,107 billion in 2026-27. Interest rates are likely to be somewhat higher but not enough to explain the big anticipated jump in costs of debt servicing.

The Federal Ministry of Finance needs to explain how the debt servicing was contained at Rs 6,947 billion, implying a reduction of Rs 1,260 billion in relation to the budget estimate. There is need also for explanation as to why there will be a quantum jump of debt servicing in 2026-27 by as much as16 percent.

The other issue of concern is why there was a need to curtail development spending by almost 20 percent in 2025-26, when the budgetary position was so favourable. There was a dire need for a quantum jump in project allocations, especially in the water resources sector, as a counter to likely actions by India after its withdrawal from the Indus Waters Treaty.

The other issue is that there is no real big augmentation in the targeted cash surplus by the Provincial governments in 2026-27. The expectation in the IMF Programme was that there will be a quantum jump in provincial tax revenues, especially in the agricultural income tax, property-related taxes and the sales tax on services. This has not happened. The larger cash surplus in 2025-26 was due more to cuts in development spending.

Overall, there is no doubt the need to appreciate the colossal reduction in the budget deficit in 2025-26 to only 2.6 percent of the GDP. However, it has been achieved entirely by reduction in expenditure and not by a rapid increase in FBR revenues, which have shown a modest growth rate of 10 percent. Also, the expenditure savings appear to have been temporary in nature.

For example, the savings in debt servicing in 2025-26 appear to be short-lived in character with a likely quantum jump of 16 percent in 2026-27. Unfortunately, the containment of current expenditure in 2025-26 was not a result of permanent cost savings in the expenditure on running of the civil government and defence services, subsidies and grants.

Therefore, we are likely to go back in 2026-27 to a consolidated budget deficit of over 3.5 percent of the GDP, with a quantum jump in debt servicing, big rise in other current expenditure and only a moderate increase in revenues. Nevertheless, there is a need to recognize the exceptional budgetary performance in 2025-26, which has also contributed to bringing down the public debt to GDP ratio by 3.4 percent of the GDP.

Copyright Business Recorder, 2026