The Government of Pakistan’s proposed budget for fiscal year 2025-26 indicates further narrowing of the fiscal deficit, says Fitch Ratings, while stressing its projections for the economy are more conservative than that of Islamabad.
In a report, the credit rating agency said it is forecasting fiscal consolidation to advance slightly faster than its previous estimations. It noted that the government’s provisional figures suggest the country’s combined federal and provincial fiscal deficit narrowed to 5.6% of GDP in FY25, from 6.9% in FY24. “The government succeeded in raising federal tax revenue, which was in line with its budgeted target as a share of GDP, though short in nominal terms given the rapid decline in inflation since June 2024,” it said.
Further, the report noted the strong fiscal performance also reflected higher non-tax revenue from the State Bank of Pakistan (SBP), underpinned by SBP repo operations that have supported commercial banks’ purchases of government debt at high policy rates. “Meanwhile, the government continued to underspend on the development budget,” it added.
The provisional figures are broadly in line with the revised quantitative performance criteria outlined in the IMF’s first review of Pakistan’s $7 billion Extended Fund Facility. However, said Fitch, tax revenue remains slightly below target.
The U.S.-based agency said the proposed budget projected the deficit to narrow further to 3.9% of GDP in FY26 due to a decline in interest rates and a further increase in tax revenue. “Planned increases in defense spending are relatively small in real terms, as spending was already higher than planned in FY25,” it said, noting the budget had also cut development spending, which would prove prevent the alleviation of structural constraints to Pakistan’s medium-term growth.
“We expect the continued restrictive fiscal settings in FY26 to contain Pakistan’s current account deficit and support a continued build-up of foreign-exchange reserves, helping it cope with ongoing large external debt maturities,” it said.
According to the report, Fitch is “less optimistic” than the government about the prospects for fiscal consolidation, and expects the overall deficit to narrow to 5% in FY26, partly due to weaker projections for economic growth. Against the government’s target of 4.2% GDP growth, Fitch expects 3.5% growth in FY26. It said this reflected conservative assumptions around progress on raising federal tax revenue, as well as a belief that interest costs would decline slower than projected by Islamabad.
“The government’s success in hitting the previous budget’s targets for tax revenue in FY25 points to the potential for Pakistan to outperform against our fiscal projections,” it said, while noting that implementation risks remain due to persistent political and security risks. “The apparent consensus within Pakistan on the need for reform could weaken over time,” it notes, adding technical challenges on initiatives such as digitalization would also be significant.
“We stated in April that positive rating action could result from significant declines in government debt and debt-servicing burdens, or further easing of external financing risks. Meanwhile, failure to keep debt and debt-servicing metrics on a firm downward path, or renewed deterioration in external liquidity, could lead to negative rating action,” it added.