Pakistan likely to hike defence spending but slash overall budget in 2025-26

Pakistan is set to unveil its annual budget, projecting a 6.7% decrease to 17.6 trillion rupees ($62.45 billion) and targeting a fiscal deficit of 4.8% of GDP, while anticipating a 20% increase in defense spending amid economic growth projections of 4.2% for fiscal year 2026. The budget aims to expand the tax base and reduce subsidies to meet IMF bailout terms, though analysts express concerns about revenue target shortfalls due to implementation challenges and the absence of meaningful structural reforms.

Analysis

Pakistan is poised to announce a 17.6 trillion rupee ($62.45 billion) federal budget for the upcoming fiscal year, representing a 6.7% decrease from the current year, as it targets a fiscal deficit of 4.8% of GDP, down from a projected 5.9%. This fiscal consolidation occurs amidst an anticipated 20% surge in defense expenditure, driven by recent geopolitical tensions, which is likely to be balanced by cuts in development spending. The government projects an optimistic 4.2% economic growth for 2025-26, a significant step up from the current fiscal year's likely 2.7% growth (which missed its 3.6% target), yet this remains substantially below the South Asian average growth of 5.8% in 2024 and an expected 6.0% in 2025. Key priorities include expanding the tax base—with only 1.3% of the population paying income tax in 2024—and reducing subsidies to adhere to a $7 billion IMF bailout program. Finance Minister Muhammad Aurangzeb has emphasized a commitment to macroeconomic stability and avoiding past boom-bust cycles. However, analysts, such as Ahmad Mobeen from S&P Global Market Intelligence, express skepticism, anticipating that revenue targets for 2025-26 will be missed due to challenges in implementing announced measures and a lack of meaningful structural reforms, particularly in taxing agriculture and retail sectors. The economic outlook is further complicated by the uncertainty of new U.S. trade tariffs and the acknowledged limitations of monetary policy, despite recent central bank rate cuts, in solely reviving investment under prevailing fiscal constraints.

Key Decisions for Investors

• Investors should closely monitor Pakistan's adherence to IMF program conditions and the execution of critical fiscal reforms, especially the politically sensitive expansion of the tax base, as these are pivotal for sustained macroeconomic stability.
• The significant 20% increase in defense spending, coupled with ambitious but regionally lagging GDP growth projections of 4.2%, signals potential pressure on development expenditures and highlights ongoing fiscal vulnerabilities that warrant careful assessment.
• Consider the 'moderately negative' sentiment and exercise caution; while interest rate cuts aim to spur growth, substantial headwinds persist from structural reform needs, U.S. trade tariff uncertainties, and skepticism from analysts like S&P Global regarding the achievability of revenue and fiscal deficit targets.
• Evaluate exposure to Pakistani assets with a clear understanding of the heightened geopolitical risks influencing budget allocations and the potential for these to divert resources from productive sectors, thereby impacting long-term economic performance.