The first article on features of the federal budget of 2026-27 was published last week, with a focus on the more aggregate trends and projections. This article looks at the federal budget in a more disaggregated manner.
We first examine the trends and projections in different sources of revenue. The income tax revenues growth in 2026-27 is expected to almost double from 9.3 percent in 2025-26 to 18.1 percent. This is anticipated despite the significant reduction in the rates of personal income tax and super tax. The expected improvement is in the audit process. However, the amount raised out of demand following audit has hitherto been under 5 percent of total revenues from the income tax.
The second optimistic projection is of revenues from customs duty. It showed a growth of only 6.4 percent in 2025-26, but is projected to rise by as much as 20.9 percent in 2026-27. The exchange rate is expected to depreciate by 4.3 percent. As such, the dollar value of imported goods is projected to increase by as much as 16.3 percent. This is substantially above the projection officially of imports in 2026-27.
The third overstated projection is related to excise duty, with the highest growth rate in revenues among the different taxes, of 26 percent. There is no visible increase in tax rates. Here the expectation is of a big reduction in tax evasion in cigarettes manufacturing.
Overall, the FBR revenue projection is visibly optimistic and we could once again see a shortfall of almost Rs 1,000 billion, as will be the case in 2025-26.
There is, however, a visible slowdown in own non-tax revenues. This is primarily due to the decline in SBP profits of 7.3 percent in 2025-26. They are now expected to fall by as much as 41 percent in 2026-27. This is primarily due to the sharp fall in interest rates from the peak level in 2022-23.
Overall, the level of own non-tax revenues of the federal government is expected to fall by as much as 16 percent in 2026-27. This explains why the provincial governments have been compelled to make a large combined grant for the first time to the federal government of Rs 1,035 billion. If these grants do flow into Islamabad in 2026-27, then the total non-tax revenues, including these grants will still show a positive growth rate of only 4.8 percent.
The petroleum levy yielded an additional 22.7 percent in 2025-26, despite the rise in international POL prices. It is expected to yield another 11.9 percent in 2026-27. The likely fall in international prices should not precipitate an escalation in the levy. The benefit should be passed on entirely to consumers. This will constitute a major source of relief in 2026-27. The big fall in petrol and HSD prices announced recently will provide substantial relief and is fully appreciated.
We turn now to a disaggregated analysis of federal expenditure. The fundamental question is why total expenditure, current plus development, will rise by as much as 20 percent in 2026-27?
Examination of the budgetary provisions for current expenditure reveals that the debt-servicing outlay is projected to rise by 16.1 percent in 2026-27. This highlights the projection of higher interest rates next year. However, the end of war in the Middle East should facilitate constancy, if not a fall, in interest rates.
The defence expenditure allocation implies a growth rate of almost 16 percent in 2026-27. This is probably required, given the tense situation both in the Eastern and Western borders, plus the rise in the incidence of terrorism in the country.
Subsidies are expected to actually decline by almost 6 percent in 2026-27. This includes some containment in the power differential subsidy. Presumably, there will not be a blanket very low tariff rate on small consumers. Instead, eligibility will be determined through a type of survey that was undertaken earlier by the BISP (Benazir Income Support Programme).
An unprecedented massive increase in grants of 36 percent has been included in the federal budget. This is after a relatively large increase of 20.8 percent in 2025-26. One of the major grants is the allocation of funds to the BISP. This has been recognized as an effective programme and the IMF Programme has also provided for an increase in the financial projections.
The grant to the BISP is proposed to be increased by 17.5 percent from Rs 729 billion in 2025-26 to Rs 857 billion in 2026-27. This will enable both an increase in coverage and in the size of a per family cash grant. This is necessary, given the underlying trend of rise in the incidence of poverty due both to rising food prices and higher unemployment.
There is, however, a very unusual item that has been included as a large recipient of grants. This is a lump sum provision of as much as Rs 365 billion in the 2026-27 budget in the form of a grant for National Economic Initiatives. The Finance Minister should have indicated the particular initiatives chosen for 2026-27 and their justification.
The level of development spending is showing a large fluctuation. It was cut back by almost 54.5 percent in 2025-26 to enable achievement of the budget deficit target for the year in the IMF Programme. The 2026-27 federal budget proposes a massive increase to Rs 1275 billion, including Rs 275 billion of lending to State-Owned Enterprises (SOEs).
Top priority ought to have been given to projects in the Water Resources sector in view of India’s plans to reduce the access to water of Pakistan. Unfortunately, this is not reflected in the sectoral development allocations, with no increase in allocations to this sector.
The National Highways Authority continues to receive the largest share of 25 percent in development expenditure. The allocation to investments in Power Transmission and Distribution is also low at Rs 105 billion, despite the high such losses in the power sector.
Finally, we come to the financing of the projected budget deficit of Rs 5,226 billion, equivalent to 3.5 percent of the projected GDP in 2026-27. A primary surplus of 2.5 percent of the GDP is also anticipated.
Within the sources of financing, the primary importance is of external financing. Ambitious targets have also been set here for the gross inflow of external financing in 2026-27. The quantum of such financing is expected to rise by over 29 percent, from USD 18.1 billion to USD 23.4 billion.
However, the really worrying magnitude is the expected quantum jump in repayments of 59.5 percent from USD 12.6 billion to USD 20.1 billion. Consequently, the net inflow is projected at only USD 3.3 billion in 2026-27, compared to USD 5.5 billion in 2025-26. This implies greater pressure on the foreign exchange reserves in 2026-27.
Overall, the 2026-27 budget is a high-risk budget with a high growth anticipated in FBR revenues, reliance for the first time on large grants from provincial grants and continuation of generation of large cash surpluses by these governments despite these grants. There is need for sectoral reallocation of the federal PSDP, with substantially large expenditure on on-going water resource projects next year. Also, non-transparent expenditure like those on unknown National Economic Initiatives must be avoided.
The focus in next week’s article will be on the Provincial budgets of 2026-27 announced recently. An analysis of these budgets reveals that the big grants to the federal government could lead to a shortfall of almost Rs 1,000 billion in the target level of provincial cash surpluses, despite big cuts in development spending. Consequently, the consolidated budget deficit could be higher by Rs 1,000 billion in 2026-27 in relation to the level agreed with the IMF.
Copyright Business Recorder, 2026
The writer is Professor Emeritus at BNU and former Federal Minister