- Retailers and online marketplaces being formally brought into the tax net to expand revenue
The finance minister promised “strategic direction” and the FY26 Budget has a coherent thought process towards that aim. The formal economy — already overtaxed — appears to have been spared, and the overall thrust is towards expanding the tax net by targeting non tax filers and removing exemptions.
According to Intermarket Securities, there is relief — albeit minor — for the salaried class and small/ medium corporates, while non-tax filers will face severe impediments in purchasing property and 4-wheelers, as well as retaining bank accounts.
Retailers are being focused on too, with e-commerce/ online marketplaces being formally brought into the tax net, and there is a push for improving domestic productivity with the reduction of custom duties on multiple lines.
Discipline under the IMF program has continued to sustain. Instead of stepping the foot on the growth accelerator too aquickly (the FY26 GDP growth target is a modest 4.2%), the Budget focuses on increasing tax to GDP and curtailing current expenditure.
The projected fiscal deficit of 3.9% of GDP may ultimately prove to be too ambitious (in part because of an optimistic non-tax revenue target), but Pakistan should still deliver its 3rd straight primary surplus, which should hold more importance for the IMF.
Moreover, despite risks to the headline fiscal deficit, the projected development expenditure for once does not appear to be completely out of reach.
The stock market is anticipated to react positively to the Budget. There has been no change to the tax rate on dividends and capital gains, which remains at 15%. This is now more favorable as compared to fixed income investments, WHT on profit on debt has been raised to 20%. Domestic liquidity is expected to continue to gravitate towards equities.
Stabilization achieved in FY25
The economy stabilized in FY25, evidenced by inflation coming off sharply, the current account swinging into surplus (a rarity in Pakistan), and the buildup in foreign exchange reserves.
GDP growth was modest in FY25, on weak agriculture dynamics and anemic industrial growth. A low base should help agriculture rebound in FY26 while manufacturing should benefit from lower interest rates.
The government aims moderate and more sustainable economic growth in Pakistan, backed by a modest current account deficit. This discipline is important to avoid the frequent balance of payment crises of the last 15 years.
Pakistan estimates a fiscal deficit of 3.9% of GDP in FY26 as against 5.6% in FY25. This improvement is premised on a broadening of the tax net and discipline on current expenditure.
While the headline fiscal deficit appears ambitious (SBP profits may fall due to lower interest rates), Pakistan should post its 3rd straight primary surplus in FY26. Importantly, the primary balance should remain in surplus.
CPI projections appear realistic, with inflation expected to converge towards the long-term mean. However, this likely dampens prospects for large cuts in the interest rates, which has already halved from an all-time high of 22% last year to 11% at present.
Geopolitical Tensions
Analysts expect the State Bank of Pakistan (SBP) to maintain the status quo in its upcoming Monetary Policy Committee (MPC) meeting due to the recent escalation in regional tensions and the surge in oil prices. However, elevated real interest rates amid subdued inflation, a two-decade high current account surplus, weak growth in money supply, and slower private sector credit uptake, despite an 11% cut in the policy rate, indicate room for further monetary easing. A de-escalation of regional tensions amid improving external inflows and macroeconomic conditions, would allow the central bank to cut rates by another 150bps during CY25.
Tensions in the Middle East have escalated following an unprecedented Israeli attack on Iran, targeting key Iranian nuclear sites and resulting in the killing of three of its most powerful officials. Moreover, remarks by the Israeli Prime Minister, vowing to continue the strikes until the goal of Iranian disarmament is achieved, have further intensified the situation. In retaliation, Iran has reportedly fired more than 100 drones toward Israeli territory. Meanwhile, Trump has warned Iran of even more severe Israeli attacks if it does not agree to terms on its nuclear program. Aggressive stances have added uncertainty to the duration of escalation and negatively impact investor sentiment.
Oil benchmark Arab Light surged by US$6.7/ bbl or 9.6% to US$76.0/ bbl on Friday in the aftermath of the escalation, aligning closely with FY26 estimate of US$75.2/ bbl. Pakistan, being an oil-dependent nation, sees its petroleum import group account for approximately 30% of total imports, making the external account highly susceptible to oil price fluctuations. Analysts estimate that a US$10/ bbl change in oil prices from their projections could increase the import bill by US$1.8 billion/ annum and raise inflation estimates by 42bps.
Analysts believe the announced budget to be non-inflationary in nature, given the absence of aggressive revenue measures and a greater focus on reforms for revenue enhancement, along with minor relief for the salaried class and industries. Moreover, tariff rationalization could help contain the prices of imported products, encouraging local manufacturers to focus on cost optimization to remain competitive. Additionally, the imposition of a Carbon Levy and the National Electric Vehicle Policy is likely to discourage the use of internal combustion engines, helping to keep the import bill in check over the long term.