Fitch warns spending cuts could weaken Pakistan’s medium-term growth

Fitch Ratings has warned that deeper-than-expected spending cuts, particularly the continued reduction in capital expenditure, could weaken Pakistan’s medium-term growth prospects despite progress on fiscal consolidation.

In its review of the federal budget for 2026-27, the ratings agency said Pakistan had maintained a clear commitment to fiscal discipline under the International Monetary Fund programme by targeting a primary surplus of 2% of gross domestic product and an overall fiscal deficit of 3.6%.

The targets follow a stronger fiscal performance in 2025-26, when the primary surplus is projected at 2.5% of GDP. Fitch attributed the improvement to aggressive expenditure cuts and a provincial surplus of 1.1% of GDP, which exceeded its expectations.

However, the agency said fiscal consolidation had relied heavily on expenditure compression amid revenue collection challenges, with capital spending bearing a significant share of the cuts.

While the strategy had helped reduce the deficit in the short term, Fitch said persistently low capital expenditure could restrict economic growth, weaken future revenue mobilisation and complicate debt management. It added that the room for further spending reductions was narrowing as expenditure pressures increased from a suppressed base.

Fitch also described the government’s tax revenue target for 2026-27 as challenging. The budget aims to raise federal tax revenue equivalent to 10.6% of GDP, which would be the highest level on record and would build on improved collections during 2025-26.

Federal tax receipts in 2025-26 are nevertheless officially projected to fall 0.7 percentage points of GDP below the target, reflecting continuing weaknesses in tax administration and difficulties in achieving ambitious revenue goals.

The agency said meeting the primary surplus target would require tax collections to continue outperforming historical trends despite a limited pipeline of new tax measures. Non-tax revenue, including profit transfers from the State Bank of Pakistan, is also expected to decline during 2026-27.

Fitch identified the budget’s dependence on a large provincial surplus as another risk because of previous fluctuations in provincial fiscal performance and coordination challenges between the federal and provincial governments.

Interest payments also remain a major constraint due to Pakistan’s large stock of short-term domestic debt and high market yields. Fitch said a rise in the policy rate in response to inflation caused by higher global energy prices could increase the risk of interest expenditure exceeding the budgeted level.

The budget projects interest payments at 39.1% of government revenue in 2026-27, compared with a median of 12.1% for countries with a ‘B’ credit rating. Fitch said the high burden reduced fiscal flexibility and crowded out priority expenditure.

Pakistan’s projected fiscal deficit of 3.6% of GDP also remains above the 3% median for ‘B’-rated countries.

Fitch currently rates Pakistan at ‘B-’ with a stable outlook.