The missing half of Pakistan’s stabilization

Pakistan has done the hard part. It has not done the necessary part.

The consolidated fiscal deficit fell to 2.61 percent of GDP in FY26, the lowest since FY04. The primary balance recorded a surplus of 2.86 percent, likely the highest on record and the third consecutive surplus. Public debt fell from 75.2 percent of GDP in FY23 to 68.4 percent in FY26.

The numbers echo an earlier episode. Between FY01 and FY07, debt fell from 73.4 percent of GDP to 46.6 percent, alongside six straight years of primary surpluses beginning in FY99. But that consolidation ran alongside average GDP growth of 6.3 percent between FY03 and FY07, driven by private capital expansion. This time it has not. Growth over FY23-26 has averaged 2.4 percent, barely ahead of population growth.

The composition of the current adjustment explains why. In FY26, revenue grew 10 percent, versus 11.4 percent nominal GDP growth, representing a decline relative to output despite a sharp rise in the petroleum levy and already-high tax rates. Expenditure fell 5 percent, driven almost entirely by a 22 percent drop in debt servicing as interest rates eased. Strip out debt servicing, and current spending actually rose 9 percent, led by defence, up 18 percent, and civil government running costs, up 16 percent. Federal development spending fell 13 percent. Subsidies fell 22 percent, largely by passing power-sector inefficiencies on to consumers. The federal pension bill crossed Rs1 trillion for the first time.

This is consolidation driven by lower interest payments, reduced subsidies and deferred development spending, not by a leaner government or a broadened tax base. High rates on a narrow base are financing the adjustment, and that combination is keeping investment away.

There is a case for optimism, but it rests on execution, not the fiscal numbers alone. External public debt fell from 25.1 percent of GDP in FY22 to 19.1 percent in FY26, with bilateral and capital-market debt, much of it Chinese, replaced by cheaper multilateral financing. The debt-servicing-to-net-revenue ratio fell from a peak of 122 percent in FY23 to 66 percent in FY26. The sovereign credit rating has returned to 2016-19 levels, with room to move towards the levels seen in the early 2000s. The main external risk is a rising share of short-term debt, which keeps rollover risk elevated.

Pakistan’s credit standing is improving for reasons that have little to do with the underlying growth model. That gives it a window to re-enter global capital markets, but the window will not remain open indefinitely. The State Bank of Pakistan should keep building reserves. The finance ministry should lock in 10-15-year capital-market debt to reduce rollover risk and support the rating. Some local debt could be replaced with foreign borrowing to free up room for private-sector credit, while an improved external financing profile should be used to help larger private players access international finance directly.

None of this substitutes for the deregulation and privatization of the energy sector that underwrote growth in the early 2000s, and is missing now. Without it, high tax rates will continue to dis-incentivize capital formation, regardless of how clean the fiscal accounts look.

The stage is set, but the window will not remain open indefinitely. Stabilization fatigue is already visible, and the political temptation to return to consumption-led growth is likely to grow the longer reform is delayed.

Copyright Business Recorder, 2026