Pakistan’s fiscal federalism has been rewritten in plain sight

Pakistan’s FY27 federal budget does more than allocate resources; it quietly rewires the country’s fiscal federalism. The constitutional architecture, including Articles 160 to 161, the 18th Amendment, and the NFC Award, remains untouched on paper. But in practice, the budget marks a decisive break from the post 2010 federal compact. Two measures stand out: IMF mandated provincial budget surpluses and nearly one trillion rupees in provincial grants to the federal government. Together, they reverse the logic of the NFC. Instead of the federation transferring resources to provinces, the provinces are now expected to transfer resources back to the federation.

This is not a formal constitutional rupture. It is something more subtle and more consequential: a hollowing out of the federal bargain without amending a single clause of the Constitution.

Pakistan’s fiscal federalism rests on the division of taxation powers, the NFC Award, and provincial autonomy under the 18th Amendment. The NFC ensures that federally collected taxes, including income tax, GST on goods, customs duties, and excise, flow from the federation to the provinces. After the 7th NFC Award, provinces receive 57.5 percent of the divisible pool, the highest share in Pakistan’s history. The 18th Amendment further insulated this arrangement by prohibiting any reduction in the provincial share.

This architecture was designed to correct Pakistan’s vertical imbalance: the centre controls the most buoyant taxes, while provinces shoulder large expenditure responsibilities. The NFC is the constitutional equaliser.

The FY27 budget turns this logic on its head. The federal government has committed to the IMF that provinces will generate 1.794 trillion rupees in surpluses, not as a provincial policy choice, but as a federal promise negotiated with the Fund. These surpluses are required to meet the federal primary surplus target of 2 percent of GDP.

In parallel, provinces are expected to transfer nearly one trillion rupees back to the federation as grants under Article 164. To make room for these transfers, provinces have slashed their Annual Development Programmes, with Punjab and Sindh absorbing more than 80 percent of the cuts.

This is a structural inversion of the NFC’s purpose. The federation honours the NFC numerically, then reclaims fiscal space through extra constitutional mechanisms. The letter of Article 160 survives; its spirit does not.

To understand why this reversal is happening, one must confront the federal government’s fiscal reality. Net federal revenues in FY27 are projected at 11.751 trillion rupees, while debt servicing alone is 8.054 trillion rupees, a staggering 68.5 percent of net federal revenues. For every 100 rupees the federation retains after NFC transfers, 69 rupees go straight to interest payments. The remaining 31 rupees must cover defence, pensions, subsidies, civil administration, and development.

Excluding debt servicing but adding PSDP, federal expenditure reaches 18.6 trillion rupees, leaving a primary fiscal gap of 6.85 trillion rupees. Without provincial compression, debt servicing would exceed 100 percent of net federal revenues. This is not a cyclical imbalance; it is structural insolvency.

From FY10 to FY27, federal primary expenditure has exceeded net federal revenue every single year. The gap widened sharply after FY20 due to high interest rates, rupee depreciation, and rising defence and pension obligations. By FY23 to FY26, debt servicing exceeded 100 percent of net federal revenue, an unprecedented situation for a sovereign state. FY27’s apparent improvement is not the result of stronger revenues or lower interest costs. It is the result of provincial fiscal compression and reverse transfers.

The FY27 budget makes the federal government’s priorities unmistakably clear. Defence spending rises 17.6 percent to 3 trillion rupees. Pensions climb 11 percent to 1.169 trillion rupees. Civil government expenditure grows 10 percent. Subsidies are cut by 8 percent, and the PSDP is effectively frozen at 1 trillion rupees. Debt servicing remains immovable at 8.054 trillion rupees.

The IMF has long viewed Pakistan’s budget execution practices as a structural governance fault line. In its Third Review of the Extended Fund Facility in May 2026, the Fund reiterated a core requirement: all non-budgeted or above appropriation expenditures must receive ex ante parliamentary approval. The IMF’s Governance and Corruption Diagnostic Assessment in November 2025 had already flagged Pakistan’s chronic reliance on supplementary grants, often approved after the fact, as a mechanism that regularizes overspending with minimal scrutiny.

Despite the Supreme Court’s interpretation of Article 84 requiring ex ante approval, the government has argued that frequent in year adjustments make such approval impractical. The IMF nonetheless credited the authorities for curtailing supplementary grants, noting that none were approved in FY24 or FY25.

That narrative has now collapsed. During the current budget session, the National Assembly approved 15.297 trillion rupees in supplementary debt servicing demands for FY25 and FY26, including an unprecedented 12.6 trillion rupees in domestic debt repayment, the largest such approval in Pakistan’s history. These demands reflect record rollover requirements, elevated interest rates, maturity bunching, and the reclassification of obligations into the current fiscal year.

Alongside this, the Assembly approved 1.036 trillion rupees in regular and technical supplementary grants for FY24 to FY25 and FY25 to FY26, covering security institutions, civil administration, development outlays, climate and disaster management, and special bodies such as the NDMA and SIFC.

Yet beneath the surface of these headline numbers lies a more troubling continuity. Despite backtoback IMF stabilization programmes, Pakistan’s fiscal machinery continues to exhibit two stubborn traits: systemic budget overruns and builtin growth across nearly every spending head. With these structural habits entrenched, the fiscal arithmetic becomes painfully predictable.

The federal government’s expanding appetite for spending is not fed not by genuine reforms but by squeezing tax revenues in the formal economy, piling on more borrowing, and forcing provinces into deeper fiscal compression. The architecture may remain constitutional on paper, but the practice reveals a centre increasingly dependent on extraordinary measures to finance ordinary governance.

The FY27 budget does not amend the Constitution, but it reconfigures fiscal federalism in practice. Pakistan is shifting from cooperative to hierarchical federalism, where the federation negotiates with the IMF and instructs provinces to deliver fiscal outcomes.

The NFC remains intact on paper, but its redistributive function is neutralised through provincial surpluses and reverse transfers. And in this slow unravelling of Pakistan’s fiscal federalism, the IMF’s enabling role remains an uncomfortable but unavoidable part of the story.

Copyright Business Recorder, 2026