Pakistan’s external calm is more fragile than it appears

Pakistan ended fiscal year 2026 with what appears, at first glance, to be reassuring external-sector news. The current account was virtually balanced, recording a deficit of just $139 million. State Bank of Pakistan reserves ended June at roughly $18.4 billion, almost $4 billion higher than a year earlier, before declining following post-year-end external payments. After years of recurring balance-of-payments crises, these numbers naturally invite optimism, but that optimism is premature.

Pakistan’s external calm does not rest on a sustained expansion in exports, nor does it rest on any meaningful improvement in productivity, investment, or international competitiveness.

It rests overwhelmingly on record remittance inflows, supported by the State Bank’s continued purchases of foreign exchange from the interbank market. The underlying arithmetic is therefore less flattering than the headline current-account number suggests.

In FY26, Pakistan ran a deficit of approximately $35.5 billion on trade in goods and services. After including the deficit on primary income, largely interest and profit payments, the shortfall widened to nearly $44 billion. That gap was almost entirely offset by secondary income inflows of $43.8 billion, including $41.6 billion in workers’ remittances. Goods exports declined during the year, while goods imports increased. This was not an export-led improvement in the balance of payments. It was a remittance-financed expansion in import capacity.

The SBP has also been consistently buying dollars from the interbank market to rebuild reserves. That policy is understandable after the near-exhaustion of external buffers during the previous crisis. But reserve accumulation should not be confused with a spontaneous strengthening of Pakistan’s external earning capacity. The central bank has been capturing the liquidity created by exceptional remittance inflows and converting it into official reserves.

Those foundations are becoming more vulnerable just as geopolitical risks across the Middle East are intensifying. If the confrontation involving Iran and the United States persists or broadens, Pakistan could face pressure through several channels simultaneously.

Higher energy costs are the most immediate danger. Pakistan remains heavily dependent on imported petroleum, while much of its oil and liquefied natural gas supply passes through or near the Strait of Hormuz. Any sustained increase in crude prices, freight charges or insurance premiums would feed directly into the import bill, domestic inflation and the fiscal cost of energy. Yet the risks extend well beyond oil.

Pakistan has become increasingly dependent on remittances from workers abroad. These inflows have risen from approximately $27 billion three years ago to $41.6 billion in FY26, an increase of more than $14 billion. Over the same period, merchandise exports have stagnated in dollar terms and declined relative to the size of the economy.

Around 54 percent of Pakistan’s remittances now originate from Gulf Cooperation Council countries. Saudi Arabia contributed approximately $9.8 billion during FY26, the United Arab Emirates $8.8 billion and the remaining GCC economies another $3.9 billion. Excluding Saudi Arabia, around $12.7 billion in annual remittance inflows originate from Gulf economies directly exposed to disruptions in regional trade, aviation, tourism, construction and expatriate employment.

This does not mean that higher oil prices automatically reduce remittances. Historically, stronger hydrocarbon revenues can support Gulf employment, government expenditure and remittance flows. The present risk is different. A regional conflict that disrupts commercial activity, transport links, financial channels or expatriate labour markets could overwhelm the otherwise positive income effect of higher oil prices.

The vulnerability lies in concentration. Pakistan is relying on a narrow group of foreign economies to generate the income that finances an increasingly large domestic trade deficit. A 10 percent decline in non-Saudi GCC remittances would subtract roughly $1.3 billion from the external account, and Pakistan has no equivalent export engine ready to replace it.

A prolonged energy shock would also weaken demand in Pakistan’s principal export markets. Higher fuel prices would complicate monetary easing in Europe and the United States, constrain household consumption and soften demand for imported textiles, apparel and manufactured goods. Pakistan could therefore face a higher import bill, weaker remittance inflows and lower export demand at the same time. That combination, rather than any single shock in isolation, is what makes the present position precarious.

Domestic economic policy, however, appears to be moving in precisely the wrong direction. Despite repeatedly declaring its commitment to export-led growth, Pakistan has made exporting progressively less attractive. Merchandise exports have declined from roughly 8.5 percent of GDP in FY22 to around 6.8 percent in FY26. Exporters now face normal corporate taxation, super tax and the withdrawal of several earlier concessions, while continuing to absorb high energy costs, expensive financing, regulatory uncertainty and unreliable infrastructure.

Exchange-rate policy has also become increasingly rigid. The SBP’s published Real Effective Exchange Rate rose to approximately 106.4 in June, its highest level in several years. A REER above 100 does not automatically establish that the rupee is fundamentally overvalued. It does, however, show that the currency has appreciated substantially in inflation-adjusted terms relative to its trading partners.

That direction is difficult to reconcile with an export-led strategy when exporters are already facing compressed margins and rising domestic costs. Pakistan appears to want the outcomes associated with an export-oriented economy without accepting the prices, incentives or policy discipline required to create one.

The contrast with the information technology and business-services sector is revealing. Exports from these activities have risen significantly, supported by preferential taxation, easier payment arrangements and a lighter regulatory structure. Where incentives are broadly aligned with export growth, foreign-exchange earnings respond.

The problem is one of scale. Services exports increased to about $10 billion in FY26, but this remains insufficient to compensate for the deterioration in merchandise trade. Pakistan cannot repair a goods trade deficit exceeding $33 billion through software exports alone, particularly while weakening the competitiveness of agriculture, textiles and manufacturing.

The nature of the import recovery is equally concerning. Non-oil imports have rebounded sharply from their post-crisis lows and are now approaching their previous peak, even though economic growth remains below 4 percent.

At least part of this recovery appears to have a significant consumption component rather than reflecting new productive capacity. Imports of completely knocked-down automobile kits have reached record levels even though local vehicle assembly remains below its earlier peak, suggesting a shift towards more expensive vehicles and higher imported content. Similar patterns are visible in smartphones and other consumer goods. Consumption is therefore recovering faster than productive capacity, a configuration Pakistan has repeatedly encountered ahead of earlier external-sector crises.

If external pressures intensify, policymakers may once again turn to administrative restrictions on so-called non-essential imports. Pakistan has run this experiment before. It suppresses industrial production, creates shortages, damages investor confidence and temporarily compresses the current account without resolving the underlying shortage of export earnings.

Longer-term fundamentals offer little comfort. Investment remains exceptionally weak despite the improvement in headline macroeconomic stability. Foreign direct investment fell to approximately $1.6 billion in FY26, while domestic savings remain inadequate to finance the country’s development needs. The much-advertised mining opportunity has yet to translate into large-scale capital inflows, partly because deteriorating security conditions in Balochistan continue to raise project costs and deter investors.

There is also a growing policy-made risk around Pakistan’s access to European markets. The European Union’s latest review of the Generalised Scheme of Preferences has again raised concerns regarding civil liberties, media freedom, enforced disappearances and judicial independence. Pakistan’s GSP+ preferences are not facing immediate withdrawal, but closer scrutiny creates another avoidable risk for an economy whose exports are already concentrated in the European market.

Pakistan’s recent external stability should therefore be understood as a reprieve rather than a transformation. The latest revisions make that distinction even clearer. Across FY25 and FY26 combined, the current account was almost exactly balanced. Pakistan did not accumulate a large current-account surplus. It accumulated remittances and official reserves while running a progressively larger trade deficit.

Those reserves are valuable, as are record remittances and a broadly balanced current account. But none should be mistaken for structural resilience. Without stronger goods exports, higher investment and a more competitive productive economy, Pakistan remains dependent on migrant workers, central bank intervention and benign external conditions. Should the geopolitical environment become materially less forgiving, the apparent equilibrium could disappear much faster than the headline numbers suggest.

The central economic challenge for FY27 is therefore not simply whether Pakistan can grow by more than 4 percent. It is whether the country can sustain that growth without once again exhausting the foreign exchange required to finance it.

Copyright Business Recorder, 2026