Pakistan’s fiscal year 2026-27 budget signals continued fiscal discipline following a sharp improvement in public finances over the past two years, but the durability of the consolidation remains uncertain due to weak revenue generation and implementation risks, Fitch Ratings said on Thursday.
The credit ratings agency said Pakistan’s overall fiscal position strengthened significantly in FY26, with the government estimating general government deficit at 3% of GDP, well below the budget target and Fitch’s expectations. The fiscal improvement was accompanied by a historic primary surplus of 2.5% of GDP, reflecting tighter fiscal management.
However, the agency cautioned, much of the FY26 improvement was driven by temporary factors that are unlikely to be repeated in FY27. According to the agency, lower interest costs resulting from policy rate cuts and the refinancing of domestic debt at lower yields played a major role in reducing the fiscal deficit. Higher-than-usual profit transfers from the State Bank of Pakistan (SBP) also boosted non-tax revenues, while lower-than-budgeted development spending helped offset a tax revenue shortfall equivalent to 0.7% of GDP.
Deficit expected to widen
Fitch expects Pakistan’s fiscal performance to remain stronger than historical averages in FY27 but forecasts the overall fiscal deficit will widen to 4% of GDP, with the primary surplus easing to 1.9% of GDP. The projections are slightly weaker than the government’s FY27 budget targets, which envisage an overall deficit of 3.6% of GDP, and a primary surplus of 2% of GDP.
Weak revenue base
The ratings agency has identified Pakistan’s narrow tax base as the biggest constraint to sustained fiscal consolidation. It noted the official estimate of tax revenue in FY26 was 10.2% of GDP, among the lowest levels for sovereigns rated by Fitch. It said Pakistan’s federal tax collection has repeatedly fallen short of official targets despite ongoing reforms.
While the government’s efforts to improve tax administration, strengthen compliance and broaden the tax base are positive, Fitch said meaningful gains are likely to take time. It has forecast tax revenue to edge up only marginally to 10.3% of GDP in FY27, while total government revenue is expected to decline to 13.5% of GDP as unusually high SBP dividend income falls in a lower interest-rate environment.
Limited room for spending cuts
Fitch said the government’s ability to offset weaker revenues through expenditure reductions is becoming increasingly limited. The FY27 budget raises development spending to 0.9% of GDP, which the agency considers close to the minimum feasible level after significant underspending in FY26.
It also noted that social spending remains low and is protected under Pakistan’s IMF-supported reform program, leaving little additional scope for fiscal adjustment through expenditure cuts.
Debt affordability
Despite recent fiscal improvements, Fitch said Pakistan’s debt affordability remains one of its principal credit weaknesses. The agency expects the general government interest-to-revenue ratio to decline to 40.4% in FY27 from a peak of 61.5% in FY24, helped by lower interest rates.
However, the ratio remains the second-highest among ‘B’-rated sovereigns and significantly exceeds the peer median of 12.7%, reflecting Pakistan’s low revenue base, high borrowing costs and relatively shallow domestic capital market.
Provincial implementation
Fitch also highlighted risks related to fiscal coordination between the federal and provincial governments. The agency expects provincial fiscal surpluses to fall short of budget assumptions because of implementation and coordination challenges. It said this risk is particularly relevant for reforms such as the agricultural income tax, whose successful implementation depends largely on provincial governments.