Between optics and austerity
Pakistan's economic policies resemble a car with two drivers, each pulling the wheel in opposite directions. One foot accelerates through aggressive fiscal spending; the other jams the brakes via tight monetary policy. This conflicting approach makes genuine economic progress nearly impossible.
Consider the recent policy stance of the State Bank of Pakistan (SBP). For most of fiscal year 2024–25, the SBP held interest rates at a punishing 22 percent, aiming to tame inflation. As inflation rates began to decline from over 22 percent in June 2024 to around 15 percent in November 2024, the central bank still kept rates high.
According to the latest Pakistan Economic Survey 2024–25, by the fiscal year-end, inflation settled remarkably lower at 4.6 percent, validating the case for a timely rate cut. In 2025, rates were gradually reduced to 11 percent, following a final 100 basis points cut in May. This delayed monetary adjustment came with a heavy cost: interest payments soared to Rs7.764 trillion over the full year, consuming the largest share of current expenditures and crowding out space for development-oriented initiatives.
Since most government securities were on floating rates, earlier relaxation of the monetary stance could have sharply reduced this burden. Such heavy borrowing costs inevitably restricted the government's budgetary room for essential public investment. The IMF has repeatedly flagged that prolonged high interest rates, while slowing inflation, also compound the fiscal burden by inflating domestic debt service costs, creating a self-defeating loop for developing economies.
Pakistan's own data reflects this policy mismatch, as the IMF noted that real GDP growth in the first two quarters of FY2024–25 remained subdued—1.3 percent and 1.7 percent—despite easing headline inflation. The Economic Survey confirms the full-year GDP growth eventually stood at 2.7 percent, highlighting the missed opportunity for higher growth had the central bank pivoted sooner.
At the same time, fiscal authorities projected ambitious numbers. Gross revenue receipts for FY2024–25 were budgeted at Rs17,815 billion, with Rs12,970 billion targeted from FBR taxes. However, the Pakistan Economic Survey 2024–25 revealed that the FBR collected a total of Rs10.23 trillion, falling short by a staggering Rs1.03 trillion—roughly 8 percent below target. This shortfall was concentrated in sales tax and customs duties, which underperformed due to import compression and disinflation, eroding the tax base.
Sales tax collections suffered as inflation cooled and domestic consumption slowed, while customs duties fell alongside declining import volumes. In contrast, income taxes showed relative resilience, primarily because they were collected at source — via employer deductions and AWT through telecom providers — rather than through voluntary compliance.
To compensate for the gap, the government leaned heavily on non-tax revenues, particularly the extraordinary SBP profits of Rs2.5 trillion (midyear figure). But these profits are tied to high interest rates and will shrink drastically as the central bank lowers rates, making them an unreliable pillar for future fiscal planning.
Moreover, these profits are not 'earned' in a conventional sense; they represent accounting transfers derived largely from interest paid by the government itself to the SBP on its own borrowing, which distorts the true fiscal picture rather than strengthening it.
Despite these revenue struggles, however, the government showcased a strong primary surplus—officially Rs3,604 billion (2.9 percent of GDP) by December 2024, although the IMF's adjusted calculations placed it at Rs2,264 billion (2.0 percent of GDP), discounting one-off SBP profits. At first glance, this signaled fiscal prudence, but it came at the expense of critical long-term investment. By year-end, actual federal PSDP disbursements stood at just Rs564.5 billion out of a Rs950 billion revised allocation, reflecting continued underutilization.
arlier in the year, only Rs296 billion had been spent by December, with verified SAP system disbursements even lower at Rs145.4 billion.
According to the Pakistan Economic Survey, despite announcing an ambitious Rs4.224 trillion development budget for FY2025–26 (including both federal and provincial components), actual public development outlays in FY2024–25 fell short at Rs3.483 trillion, raising doubts about realistic planning.
This sharp underutilization reflects a broader pattern: when budgetary room tightens, investment is the first casualty, regardless of stated priorities. Even the IMF acknowledged in its Article IV consultations that the surplus has been achieved primarily through expenditure compression—especially in public infrastructure spending—rather than through structural revenue improvements.
It also highlighted that while headline inflation had eased to 0.3% month-on-month by April 2025, core inflation persisted at 9%, reflecting stubborn price pressures in non-volatile categories.
Another silent drain on the economy often overlooked is the cost of managing a high-cash economy. During July–March FY2024–25, currency in circulation rose by Rs1,108 billion. This rising demand for cash reflects limited financial inclusion and forces the government to service liquidity needs at high borrowing costs, adding another layer of fiscal inefficiency.
Simultaneously, regressive taxation persists, such as advance income tax deductions on mobile phone top-ups, disproportionately affecting the lower-income population.
Defense spending, projected to rise by 12.2 percent to Rs2.4 trillion in the FY2025–26 budget by the IMF, reflects the security imperatives of a region marked by persistent tensions. While national defence remains non-negotiable — especially amid the ongoing security challenges posed by recent tensions with India — it reinforces the urgency of making what remains of the fiscal envelope count, particularly for social protection and growth-oriented projects. With 110 million citizens living below the poverty line, the challenge lies in balancing essential defence spending with meaningful investment in human capital.
In recent developments, the National Economic Council (NEC) approved the Annual Development Plan for FY2025–26, allocating Rs4.224 trillion for development projects—Rs1 trillion earmarked for federal schemes and Rs2.869 trillion for provincial initiatives.
The ambitious Rs4 trillion-plus allocation underscores the government's renewed commitment to key sectors like health, education, infrastructure, and housing. However, credibility remains in doubt. For FY2024–25, the federal PSDP was originally set at Rs1.4 trillion but was later revised downward to Rs1.1 trillion. As of May 2025, only Rs596 billion had actually been utilized—a staggering shortfall of over Rs800 billion.
This underuse not only reflects fiscal constraints and delayed releases due to IMF-agreed targets, but also exposes the limited absorption capacity of ministries. The gap between announced intentions and actual execution continues to widen, reinforcing skepticism about whether the new targets represent genuine developmental intent or political optics. This pattern highlights a persistent policy disconnect: debt servicing, inflated by high interest rates, forces cuts in long-term investment.
Capital spending, meant to boost sustainable growth, becomes the first casualty in a budget strained by security needs and costly borrowing. Compounding the challenge, total government debt surged by Rs6 trillion in the first ten months of FY2024–25, reaching Rs74.936 trillion due to increased borrowing amid revenue gaps.
Externally, the economic picture shows paradoxical stability. According to the Economic Survey, Pakistan's current account surplus stood at $1.9 billion from July–April FY2024–25, largely due to a robust 30.9 percent surge in remittances. Foreign exchange reserves improved to $16.64 billion by May 27, exceeding IMF targets, and the exchange rate premium narrowed significantly.
Meanwhile, one critical missing link is subnational fiscal performance. Provincial governments must urgently broaden their tax base—particularly through better collection of sales tax on services, property tax, and agriculture income tax. These are constitutionally devolved responsibilities, yet provincial revenue performance remains abysmal, with excessive reliance on federal transfers. Without a meaningful push to mobilize own-source revenues at the provincial level, the burden will continue falling on a narrow federal tax base already stretched to the limit.
This disconnect between external calm and internal dysfunction only emphasizes the core incoherence: while monetary policy was stuck in overcorrection, fiscal management was running on promises and patchwork. Had the SBP lowered rates sooner, debt servicing costs would not have consumed half the fiscal oxygen. Had tax targets been met, they would have equaled nearly $3 billion—roughly matching a full year's IMF disbursement under the Extended Fund Facility. Instead, Pakistan finds itself spending more to service past borrowing, all while cutting the very investments that could fuel future growth.
To escape this policy gridlock, Pakistan must replace its economic tug-of-war with synchronized steering. Fiscal discipline must mean more than cosmetic primary surpluses built on cuts to growth-oriented spending. Monetary policy must respond dynamically; taking into account inflation and the broader fiscal context. Tax reform must go deeper than administrative tweaks. And capital investment must stop being treated as optional.
If both drivers can agree on a common direction—growth through coordination—there is still time to turn the wheel. But without that alignment, the vehicle will keep swerving off course, stuck in a loop of conflict, correction, and chronic stagnation.
Copyright Business Recorder, 2025
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