Pakistan’s high-stakes budget

The political backdrop is notably altered as Pakistan prepares to unveil its FY2025–26 budget. The recent brief military engagement with India along the Line of Control, one from which Islamabad has emerged with a measure of tactical success, has renewed national confidence. Yet military victories, however stirring, do not resolve balance-of-payments crises, mend structural inefficiencies or restore investor trust.

The task before policymakers is formidable: converting geopolitical momentum into economic credibility. This year’s budget is not merely an accounting exercise but a statement of intent. Will the government use this moment to accelerate long-stalled reforms, taxation, energy pricing and debt management or revert to the familiar pattern of populist expenditure and political expediency?

The challenge for Islamabad is acute: it must prove to the IMF, creditors, domestic stakeholders and a fatigued public that the recent stabilisation is not a fleeting IMF-induced illusion but the first act of sustained reform. With the IMF’s Extended Fund Facility (EFF) and the newly approved $1.4 billion Resilience and Sustainability Facility (RSF) acting as lifelines, the upcoming budget is more than an exercise in balancing books. It is a moment of reckoning.

By some measures, Pakistan’s economy is indeed on firmer ground. Foreign reserves have climbed to $10.3 billion as of April 2025, up from a perilously low $9.4 billion in mid-2024, and are projected to reach $13.9 billion by end-June. Inflation, which surged to double digits last year, has slowed markedly this year, aided by improved agricultural supply chains, currency stability and tight monetary policy. The State Bank of Pakistan has responded by slashing policy rates by 1,100 basis points since June 2025, hoping to rekindle dormant private investment.

The current account is back in surplus, underpinned by resilient exports and a rebound in remittances from the Pakistani diaspora. Yet these green shoots remain fragile. Real GDP growth in the first half of FY25 remained tepid at just 1.3–1.7 per cent, well below the government’s ambitions. Though marginally improved, investment continues to lag: the fixed investment-to-GDP ratio rose to 12 per cent from 11.4 per cent last year, still shy of the 12.5 per cent target. Private sector investment rose slightly to 9.1 per cent of GDP, while public sector investment hit 2.9 per cent, contingent on full execution of the Rs1.1 trillion development budget.

On the other side, the structural impediments are well-known and long-standing. Pakistan’s tax-to-GDP ratio remains among the lowest in emerging markets, plagued by elite capture, non-compliance, and exemptions that erode the revenue base. Encouragingly, all provinces have now passed legislation to tax agricultural income, a long-overdue breakthrough. But the real test will lie in implementation. Will Pakistan’s politically powerful landed elites finally be brought into the tax net? Or will the new law prove to be another symbolic gesture with minimal enforcement?

The IMF is also pressing for the abolition of the ‘non-filer’ category, which enables high-value transactions by those outside the tax net, and for the rationalisation of tax expenditures, revenue foregone through legal exemptions and preferential treatments. The upcoming budget will need to codify these changes into law, publish a full tax expenditure review, and enforce digital compliance in the real-estate and retail sectors. Otherwise, the fiscal burden will fall disproportionately on the salaried class and formal businesses, choking productivity and worsening inequality.

No Pakistani budget can claim credibility without tackling the energy sector’s chronic inefficiencies. The circular debt, an ongoing accumulation of unpaid bills in the electricity value chain, has ballooned past 2.2 per cent of GDP. While recent tariff hikes and better bill collection have slowed its growth, structural fixes are overdue. The IMF expects the government to commit to annual rebasing of electricity tariffs starting July 1, ensuring cost recovery and improved cash flow for power producers. Another litmus test is legislation for the Captive Power Transition Levy (CPL) to move industrial users from inefficient gas systems to the national grid.

A proposed sukuk bond to refinance legacy debt held by the Central Power Purchasing Agency (CPPA) could offer short-term liquidity relief, but it must be paired with hard conditionalities, disciplined subsidy targeting, improved governance, and a legally binding commitment to eliminate circular debt accumulation by FY2031.

Just as the government prepares to reallocate spending towards human development and climate resilience, the renewed security threat from India threatens to hijack fiscal priorities. Military spending could face upward pressure, especially if hostilities persist or public sentiment demands a show of strength. Any such shift risks crowding out desperately needed outlays on health, education, and social protection sectors, already underfunded at below 2.4 per cent of GDP.

This trade-off comes at a perilous time. The Benazir Income Support Programme (BISP), one of the few functional social safety nets, has been expanded to cover 10 million families. Maintaining these real benefit levels is critical for social cohesion and bolsters the government’s legitimacy. Similarly, reversing the decline in provincial education and health spending is vital for long-term productivity gains.

The RSF brings both obligation and opportunity. To unlock its full disbursement, Pakistan must align its Public Sector Development Programme (PSDP) with climate goals, integrating disaster preparedness, efficient water pricing and resilient infrastructure into fiscal planning. Transparency in climate-related financial disclosures and the embedding of green metrics in project appraisals are now structural benchmarks under the facility. The upcoming budget must earmark tangible resources for these priorities or risk forfeiting not just RSF funding but broader investor confidence.

Budget 2025-26 will serve as a litmus test for Pakistan’s reform resolve, with four critical indicators to watch. First, tax reform credibility hinges on whether the newly legislated agricultural income tax will be implemented effectively and whether long-standing exemptions, often exploited by elites, are finally curtailed. Second, the energy sector’s rehabilitation depends on the government’s willingness to enforce full-cost electricity tariffs and legislate the CPL, key to reducing the fiscal drag of circular debt.

Third, the delicate balance between social investment and security spending will be tested as the recent India-Pakistan tensions risk shifting budgetary focus toward defence, potentially at the expense of essential education and health allocations. Finally, the budget’s alignment with the RSF will be scrutinised, particularly in terms of how it incorporates climate-related goals and whether a revised debt management strategy reduces reliance on short-term, high-cost domestic borrowing. These signals will reveal whether the government is charting a path toward sustainable reform or slipping back into crisis-driven governance.

For Islamabad, this is more than a fiscal exercise; it is a defining moment to address structural, strategic, and societal challenges in tandem. If managed with resolve, it could mark a turning point from the constraints of crisis economics to the foundations of credible and enduring statecraft. Delivering on this front will require political will, technocratic clarity, and policy consistency traits that have too often been elusive but are now indispensable.

If the government rises to this moment with clarity and courage, the budget could mark not another chapter of survival economics, but the cautious start of a steadier, more confident future. The opportunity is real, but so is the risk of falling short.

The writer is a senior lecturer in finance, leading International and Transnational Education at Birmingham City University’s College ofAccountancy, Finance and Economics. He tweets/posts @HafizUsmanRana