- Fiscal deficit projected at 5% with high revenue growth and limited government spending focus
Perspective of Mr. Basharat Ullah Khan, Head of Business Development & Research, Spectrum Securities Limited on the Federal Budget for 2025-26.
Profile:
Mr Basharat Ullah Khan has long experience in Pakistani capital markets-managing equity/fixed-income funds, investment advisory, buy/sell-side research, mutual funds etc. He has held key management positions such as chief investment officer, head of operations, head of research in asset management companies and brokerage houses. Presently, he is associated with Spectrum Securities.
Pakistan & Gulf Economist approached Mr. Basharat Ullah Khan, Head of Business Development & Research, Spectrum Securities Limited for his perspective on the Federal Budget for 2025-26. Following are the excerpts:
Budget FY26 is the usual balancing act with focus on keeping the fiscal deficit in check and remaining fully compliant with IMF conditions. Government’s weak fiscal position and low foreign exchange reserves is the major constraint in providing stimulus for growth through high government spending. The reduction in policy rate to 11% from 22% during this fiscal year has created some room for spending, however, government has opted to stay on the course of caution and pragmatism.
There is clearly an attempt in numbers to reduce fiscal deficit to 5% of GDP in FY26, with main focus on reducing total expenditures (just 2% growth), while increasing total revenues by 15%. This year budget also demonstrates that government is in no hurry to give any major stimulus through its own spending as reflected in curtailment of development spending.
On the revenue side, total revenue growth for FY26 is projected at 15% to Rs 19,278bn as against very strong growth in last two years (39% in FY24 and 37% in FY25). This will include 19% increase in tax revenues to Rs 14,131bn and only 5% growth in non-tax revenues to Rs 5,147 bn. While tax revenue growth targets are expected to be achieved, government has realistically lowered growth estimate for non-tax revenues given the uncertainty over profits of SBP and petroleum levy. Net revenues of the federal government will stand at Rs 11,072bn after disbursement of Rs 8,206 NFC award to provinces.
On the expenditures side, major component remains debt servicing cost that is projected to decline by 8% to Rs 8,207bn. This reduction in interest expense reflects the fall in policy rate from 22% to 11%. Given the total public sector debt near Rs80bn and approximately Rs 6.5bn addition next year (fiscal deficit), debt servicing cost will continue to be the top expenditure in Pakistan budget. This estimate also reflects that government is not projecting further easing as such in interest rates in FY26. Defense spending will remain the second biggest expense projected to increase by 19% to Rs 2,550bn compared to 15% increase in FY25. This increase has come in the wake of recent military clash between Pakistan and India, which has prompted the government to strengthen its defense capabilities by acquiring modern equipment of air defense system, fighter plans, drones etc. If border situation remains tense and there is no breakthrough in talks with India, defense spending could be even higher than what has been budgeted for FY26. At the same time, subsidies have been reduced by 14% to Rs1,186bn and development expenditures lowered by 9% to Rs 1,000bn. Overall, total expenditures have been projected at grow by just 2% to Rs 17,573bn. Thus, high growth in revenues and lower growth in expenditures will lead to fall in fiscal deficit to Rs 6,501b (5% of GDP) in FY26.
Government has disclosed that provisional GDP growth during FY25 is estimated at 2.68%, based on last three quarters or ten months data and recent crop estimates. In our view, decline in wheat output in recent months and overall week crop data, indicate that GDP growth in FY25 after incorporating 4Q data will fall short of what the government has announced, and it is unlikely to exceed 2%.
Analysis of GDP and its broader segments and sub-segments points to shrinking output in majority segments. Large scale manufacturing had declined by 1.47% in 9 months (July-March 2025). Q1, Q2, Q3 GDP growth numbers were 1.37%, 1.53%, 2.4% respectively. Along with this production of major crops (wheat, cotton, maize, sugarcane, rice) has declined by 13.5% during the current fiscal year. Per economic survey, total growth in agriculture output was recorded at only 0.56% in 2024-25 compared to 6.25% growth in 2023-24. This overall increase has come on the back of strong growth of 4.72% in livestock and 4.78% rise in small crops. The numbers in these two sub-segments are not based on exact data and have mostly been used to tweak the GDP number.
While government has announced some minor measures to support the farming economy, we believe price level of agri products will play a crucial role. Most significantly, water availability and favorable weather conditions is a new uncertain variable, government should not be placing unnecessary restrictions on exports of agri outputs in order to ensure better pricing for farmers. If the incentive of earning better return is missing in crops, farmers will look for alternative such as livestock and related activities. Following two tough years for farmers, expectations are that farm prices should not fall from current levels, and which may even increase next year, it should therefore lead to relatively higher cultivation and improved crop output next year. Similarly, slow growth in manufacturing is also expected to move in positive territory during next fiscal year due to low base effect amid expected improvement in consumer demand following some relief in taxes on salaries. There is high probability that GDP growth to pick up to near 4% in FY26.
Asset allocation views
Equities will remain the preferred asset class. Government has announced some drastic measures by increasing withholding tax on fixed income mutual funds (money market and bond funds) to 25% from 15%. At the same time, withholding tax on interest income of depositors (savings and term deposits) has been increased to 20% from 15%. At the same, withholding tax on equity funds has been left unchanged at 15%. Similarly, CGT on shares and withholding tax on listed companies’ dividends has been retained at 15%. More so, investment in NSS will also attract the same 15% withholding tax on income.
As expected, stock market rejoiced this announcement with 1.91% increase on the first day of post-budget trading amid expectations of increased inflows into stock market and equity funds following these proposed changes in budget.
Pakistan equities remain at attractive level based on valuations (discount of prices to fair values) and dividend yield. During FY25 (from June 30, 2024 till June 11, 2025), KSE100 has gained 58% to presently at 124,352 (new all times high). Notwithstanding market volatility in May 2025, when market plunged by 18% to near 102K during border clashes with India, market has bounced back strongly 21% after the ceasefire on May 10. This shows the resilience of the market with local investors opting for increasing allocation to domestic equities.
Fixed income will lose its charm
Attraction of fixed income products such as fixed income funds and bank deposits will diminish further as the net returns (after tax) will slash going forward in single digit to near 6-7% average, after the increase in withholding taxes on fixed income mutual funds and bank deposits.
Key thing is whether there will be further monetary policy easing going forward (policy rate at 11% presently), as government has increased CPI target to 7.5% in FY26 compared to near 4.5% average in FY25. The decline in this year CPI was mainly due to fall in food index items (35% weight). Most significantly rupee parity vs USD remained unchanged near 280 vs USD during past 20 months, which has been one major reason for bringing down local inflation in line with countries where the exchange rates have been stable.
In my view, there is low probability of further easing in the policy rate and SBP would prefer to keep the rate unchanged at 11% for many months in next fiscal year. The decision to ease further will be dependent on forward view on inflation, current account position, balance of trade and most importantly foreign exchange reserves. Fall in reserves or slow growth in foreign exchange reserves will be the main factor that could put pressure on Rupee. Fall in rupee has been one major reason for domestic inflation, therefore, SBP would prefer to keep the real exchange rate positive in order to avoid pressure on rupee.
NSS should attract higher inflows
There is high probability of more inflows in National Saving Schemes (NSS) products as the withholding tax on government backed fixed income instruments remained unchanged at 15%. Many investors who are presently invested in money market funds may move their savings to NSS, where the after-tax returns are higher. Higher inflows in NSS will be positive for the government as raising funds in unfunded debt will reduce its reliance on bank borrowings for fiscal deficit.