The fragility behind the fiscal gains

EDITORIAL: The finance ministry’s summary of fiscal operations for 2025-26, published on August 13, offers welcome evidence of an improvement in Pakistan’s financial position, with the fiscal deficit falling to a 22-year low of 2.6 percent of GDP, or Rs3.3 trillion.

The progress rests on a combined provincial surplus of Rs1.449 trillion, Rs1.967 trillion in savings on domestic debt servicing and stronger petroleum levy collections, with the government also posting a primary surplus of Rs3.634 trillion, equivalent to 2.9 percent of GDP.

On the face of it, these numbers suggest fiscal consolidation efforts have, at least for now, restored a measure of stability to key metrics of the economy, helping arrest the double-digit growth in public debt, which still rose by seven percent over the year. Yet it would be premature to read these developments as proof that the economy’s underlying fiscal malaise has been resolved.

For all the relief of a 22-year-low deficit, it nevertheless remains substantial when set against Pakistan’s colossal accumulated debt and stubbornly narrow revenue base. Much of the improvement stems less from any fundamental strengthening of the revenue position than from provincial surpluses, savings on domestic debt servicing and expenditure restraint on development projects.

The FBR, it must be noted, still cannot demonstrate the capacity to meet the revenue goals it commits to, falling short of its IMF-agreed target, indicating that its contribution to the fiscal improvement remains far less consequential than one would have hoped. Public debt, meanwhile, continues to exert a corrosive drag on the economy, diverting scarce resources to debt servicing and leaving the government precious little room to absorb economic shocks.

Importantly, financing a deficit running into trillions keeps the government’s appetite for borrowing large, crowding out credit and investment that would otherwise flow to the private sector, while heavy debt servicing keeps development spending on a short leash and stokes inflationary pressures.

That pressure, in turn, lands squarely on the monetary policy, with the central bank ending up holding rates tight, currently at 11.5 percent. Businesses and investors bear the price, facing borrowing costs steep enough to dampen economic activity and business confidence. It is clear, then, that fiscal consolidation is an essential precondition for the monetary breathing room that sustainable growth ultimately depends on.

The importance of fiscal discipline is also borne out by Pakistan’s recent sovereign credit-rating upgrade to ‘B’ by S&P Global Ratings, signalling greater confidence in its macroeconomic stabilisation and external position.

A ‘B’ rating, however, sits well below investment grade, a distinction that matters enormously as institutional investors and foreign capital often operate under mandates barring exposure to sub-investment-grade sovereigns, and where they do invest, they demand a steeper risk premium.

As S&P’s director of sovereign credit ratings recently noted, any further upgrade for Pakistan’s credit rating will hinge on a fiscal deficit held below three percent of GDP on a sustained basis, government debt brought under 60 percent of GDP, and external debt reduced to under 100 percent of current account receipts. In short, ratings agencies are watching for consistency, and not just a single good year.

What Pakistan needs is sustained reductions in the fiscal deficit rooted in durable revenue mobilisation through widening the tax net, lifting tax receipts on a lasting basis while also curbing avenues of profligate government spending. That would strengthen the sovereign balance sheet, create room for lower interest rates and improve the investment climate.

The government has demonstrated that fiscal stabilisation is possible; but without further progress, this fragile equilibrium could unravel quickly, taking with it the hard-won gains it has managed to secure so far. Pakistan cannot afford another cycle in which temporary fiscal relief substitutes for structural reform.

Copyright Business Recorder, 2026