Shazmah Fatima

Pakistan’s Federal Budget FY2026-27, presented in June 2026, is officially framed as a part of an "economic stabilization” and “fiscal discipline” package. However, beyond the political rhetoric lies a more troubling reality because this budget is prioritizing debt servicing over domestic economic stimulation. The fiscal architecture is based on total expenditure of around Rs 17.5 trillion and does not seem geared towards stimulating growth; it appears locked in a vicious circle of debt, where debt is paid back by borrowing.

This leads to a budget structure in which most spending is already allocated to servicing debts and defence, while human development, industrial growth, and structural reform remain chronically underfunded.

Budget in a Household Analogy

Before examining the details, let's explain what a national budget is! Imagine Pakistan as a big family. Each year, the head of the house (the government) determines the income and expenditures for the year. You have a salary in your household. For a country, "income" is derived from taxes collected from citizens (income tax and sales tax), non-tax revenue (from state-owned enterprises, fees, and penalties), and loans from local and international financial institutions. In terms of spending (expenses), suppose your family spent 60% of your salary just on interest on old loans taken some years ago; another large portion goes to security and protection for the house. Then, day-to-day government operations like Salaries for staff and electricity bills, and there is very little left to repair the roof, educate the kids, or improve the garden (development/PSDP).

The problem with the 2026 budget

From the 2026 budget, it is clear that the household is facing difficulties. The government expects to collect PKR 12.9 trillion but spend PKR 17.5 trillion. This "gap" of PKR 5.9 trillion is known as the budget deficit. The government borrows more, and so, interest payments will be even greater next year. This is the "Debt Trap" in simple words.

A Country in a Vicious Circle of Stabilization

The 2026 budget is not only a short-term fiscal plan; it is also heavily shaped by Pakistan's ongoing macroeconomic instability. The nation has remained in an uninterrupted IMF programme cycle since 2022 and has once again relied on external financing to address balance-of-payments pressures. Pakistan has entered yet another IMF programme by 2026; the structural inability to make a shift towards fiscal sustainability is obvious.

It is at the core of debt servicing, and this instability is shifting from being a budgetary constraint to the main one. Now, as much as half of federal revenues is being absorbed by payments, interest, and new borrowing is actually required to pay off old debt. At the same time, the energy sector is a fiscal black hole with circular debt exceeding PKR 3 trillion and long-term capacity payments obligations with IPPs.

The erosion of human capital is another critical dimension of the crisis. Local productivity is further reduced by the significant scale of skilled labourers leaving the country, particularly in engineering, medicine, and information technology. However, the tax system is still very narrow, heavily targeting wage earners, and politically powerful areas are still not taxed sufficiently.

Structural Features of the 2026 Budget

In FY2026-27, the federal budget is around PKR 17.5 trillion, with a highly ambitious revenue target of PKR 12.9 trillion. That's primarily dependent on indirect taxes rather than a meaningful expansion of the tax base, such as sales and petroleum taxes. The debt servicing pattern covers approximately PKR 9.5 trillion in expenditure. This one category outlines the fiscal environment that reduces or eliminates the possibility of development planning. The defence budget allocation of PKR 2.2 trillion is also the second highest, with a substantial amount of public funds still being spent on defence requirements. In contrast, the Public Sector Development Programme could be curtailed at a point in the year, as is the case when fiscal consolidation measures are imposed by the IMF. Originally, this was to be higher, but in history, it has always been lowered as the year progressed, particularly if there's a revenue shortfall.

Regressive Taxation and Political Economy Constraints

One of the key characteristics of the 2026 budget is its continued reliance on regressive tax regimes. In contrast to the widening of the tax base, the fiscal changes have been borne mainly by the middle class, who currently pay more direct taxes than indirect taxes.

Political economy constraints are very entrenched, and thus, this imbalance persists. The landed elites in legislative institutions still influence agricultural income, which is not well taxed, despite its large share of GDP. Similarly, the retail trade sector has yet to be formally documented and thus cannot fully contribute to national income. Besides, they continue to face difficulties in doing retail business, as formal documents limit their contribution to national income. The result is a tax system that is both structurally unfair and leaves informal and politically protected sectors unengaged. This imbalance reduces revenue and creates unfairness in the system.

State-Owned Enterprises as Fiscal Liabilities

SOEs remain one of the key structural weaknesses of Pakistan's fiscal system. There is a need for consistent financial assistance through bailouts and sovereign guarantees. While this is yet another wave of reform rhetoric, there is no clear blueprint for privatization in the 2026 budget. Instead, fiscal transfers to loss-making entities continue, absorbing hundreds of billions of rupees every year.

Dysfunctions and Structural Lock-in in the Energy Sector

One of the most structurally imbalanced sectors in the Pakistani economy is energy. Large amounts of subsidies and capacity payments are still planned in the 2026 budget, and a substantial proportion of these is paid out to unutilized generation capacity under long-term contracts. This creates a structural paradox: tariffs are raised continuously to reduce fiscal pressure, but they become less affordable, people consume less, and per-unit cost recovery declines. This is a vicious circle that leads to rising prices, declining demand, and worsening fiscal imbalance. If distribution companies do not undergo structural reform and transportation tariffs remain unchanged, and the long-term trajectory of tariff increases continues, incremental adjustments to tariffs are unlikely to fix inefficiencies.

The Growth Constraint: IMF Conditionality

Fiscal consolidation is the priority in the budget for 2026, which is driven by IMF conditionality. The expected outcomes of primary surplus and reduction in subsidy expenditures are, at the same time, limited aggregate demand and investment capacity.

The central paradox is between stabilization and growth. Limiting the economy increases external credibility but slows the domestic economy. The modest growth of GDP keeps the economy at a level that will not be able to absorb the extra labor force, in particular, the annual flow of young people joining the labour market. This leaves a structure that is unbalanced and is stabilized at the cost of medium and long-term productive capacity.

Human Development Deficit and Sectoral Imbalance

Pakistan is still far behind other countries in the region on human development indicators. This leaves little money in the budget for investment in education, health, and research and development activities, though the federal budget is rather heavily weighted toward defense spending and paying down debt.

While education and health are provincial powers, the federal government’s investment in higher education, scientific research, and climate adaptation is limited, indicating a general lack of strategic long-term planning. This imbalance can have grave consequences for the competitiveness of an increasingly innovative and eco-friendly global economy.

A Budget Without Structural Transformation

The overall picture of the FY2026-27 budget is one of continuity, not transformation. This underscores the continuity of existing fiscal trajectories and fails to address the structural drivers of these trends: narrow tax bases, lack of energy efficiency, debt dependence, and institutional inefficiency. The big risk, other than a fiscal collapse of some sort, is fiscal stagnation in the future. Once the tax rate is lowered, the tax system becomes unsustainable due to rising fixed obligations. The fiscal cycle will further stress, rather than ease, fiscal pressures unless structural changes, particularly in tax, energy, and governance, are achieved.

The current 2026 budget is fairly level; it's not a significant step forward. It is simply building on constraints without questioning them, thereby calling into question the sustainability of Pakistan's economic paradigm.

Disclaimer: The views expressed in this article are solely those of the author and do not necessarily reflect the official stance of The Himalayan Research Institute Pakistan (THRIP)

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Shazmah Fatima is an independent researcher and a final-year International Relations student at Riphah International University, Pakistan. Her research focuses on international relations, global affairs, and governance, and she has experience in policy research and academic writing.