Key features of federal budget FY27

The federal budget for 2026-27 has both important positive and negative features, which are identified below. We first highlight the positive element in the budget.

Success in fiscal stabilization

There has been visible progress in stabilization of public finances in the country. The bottom line in terms of the size of the consolidated budget deficit of the federal and provincial governments is a big containment of this deficit. It was as high as 7.7 percent of the GDP in 2021-22. It remained, more or less, unchanged in 2022-23.

The big fall came in 2024-25 when it came down sharply to 5.4 percent of the GDP and to the very low level of only 3.0 percent of the GDP this year, in 2025-26. This is one of the lowest-ever levels of deficit.

The fall in the deficit was due to a marked improvement in revenue generation at the federal level. The tax-to-GDP ratio jumped up by as much as 1.2 percent of the GDP and the non-tax revenue to GDP ratio by 1.4 percent of the GDP in 2024-25. The entire reduction of 2.4 percent of the GDP in the budget deficit was due to this unprecedented jump in revenues.

Simultaneously, the net budget deficit, excluding the debt servicing, was 1.1 percent of the GDP in 2023-24. This was converted into a large primary surplus of 2.2 percent of the GDP in 2024-25.

The further large decline in the budget deficit from 5.4 percent of the GDP in 2024-25 to the likely level of only 3 percent of the GDP this fiscal year is apparently due to the expected decline in debt servicing from 7.6 percent of the GDP in 2024-25 to 5.5 percent of the GDP in 2025-26. However, it is not clear as to how this has happened as there has been no marked reduction in interest rates in 2025-26.

Turning to the targets for 2026-27, the expectation is that the consolidated budget deficit will rise somewhat to 3.6 percent of the GDP from 3 percent in 2025-26. This is close to the projection of public finances of Pakistan made by the IMF Staff in the Third Review Report of the on-going program.

The projections for 2026-27 are, first, that the net revenues of the federal government will remain unchanged at 8.2 percent of the GDP. Total federal expenditure is expected to rise by 0.9 percent of the GDP. This will be partly compensated for by 0.3 percent of the GDP increase in the cash surplus of the provincial governments, leading thereby to an overall increase in the deficit by 0.6 percent of the GDP.

This brings us to an unprecedented development, as follows:

Provincial grants to the federal government

The federal budget documents reveal that for the first time the federal non-tax revenues will be augmented by grants/receipts under Article 164 of the Constitution of Pakistan. This reverse transfer is expected to compensate for the decline in the transfer of SBP profits of Rs 993 billion.

The magnitude of the proposed provincial grants to the federal government is large at Rs 1,035 billion. The Article 164 states that a Province may make grants for any purpose, notwithstanding that the purpose is not one with respect to which a Provincial Assembly may make laws.

The ‘squeezing’ of provincial governments

The new regime of reverse grants from the provincial governments to the federal government has been accompanied by the assumption in the federal budget that the provincial governments will still continue to generate large cash surpluses to restrict the size of the consolidated budget deficit.

The four provincial governments combined are expected to generate a large cash surplus of Rs 1,794 billion in 2026-27. This is 30 percent more than the likely level this year.

The federal budget documents also reveal that the consequential impact of generation of large cash surpluses and grants to the federal government will be a big cut in development spending by the four provincial governments combined of over Rs 600 billion, equivalent to a fall of 22.5 percent.

There is need to wait for the announcement of the provincial budgets of 2026-27 to see if there is adherence to the targets set by the federal government. There is the strong likelihood of lower cash surpluses in the presence of large reverse grants to the federal government.

However, this may motivate the provincial governments to mobilize more own-revenues. In fact, the IMF Programme includes a ‘resource mobilization’ effort of Rs 400 billion from own-sources in 2026-27, especially the agricultural income tax. This implies that if the provincial governments are to get out of the ‘squeeze’ on their revenues, they will have to generate additional revenues of 54 percent over the previous year’s level.

The Finance Minister in his budget speech should have clearly described the big change in inter-governmental fiscal relations by resort to Article 164 of the Constitution.

Ambitious FBR revenue target

The performance of FBR in 2025-26 has been disappointing. Tax revenues at the federal level are likely to show a growth rate of only 10.5 percent, implying thereby a big shortfall of Rs 1,148 billion in relation to the target for the year.

An ambitious target has been set for FBR revenues in 2026-27 of Rs 15,264 billion. This represents a big increase of Rs 2,281 billion over last year’s level, equivalent to a growth rate of 17.6 percent.

The national tax base is projected to increase in nominal terms by 12 percent, with real GDP growth rate of 4 percent and an inflation rate of close to 8 percent. Therefore, FBR revenues will need to show an additional growth of 5.5 percent. The surprising aspect of the individual revenue targets is that the growth rates of direct and indirect taxes are, more or less, the same.

The federal budget does not propose any major reforms to raise significant additional revenues. There are more proposals for a number of small tax reliefs, which combined together would imply a significant loss of revenues.

Overall, the federal budget for 2026-27 has come with a number of surprises. These include, first, a new process of transfers of over Rs 1 trillion of provincial grants to the federal government. Second, an ambitious revenue growth rate of 17.6 percent has been set for FBR revenues, without any major taxation proposals for generating more revenues and with reliance on unlikely improvements in tax administration.

Third, the provincial governments are being squeezed due to grants to the federal government leading to a projected fall of over 22 percent in development spending. This will be happening at a time when basic services like education, health, water supply and sanitation, etc., need to be greatly expanded. This is likely to retard the process of human development in Pakistan.

The next article will undertake a more disaggregated analysis of various parts of the Federal budget 2026-27.

Copyright Business Recorder, 2026