ISLAMABAD: Pakistan’s economic recovery has been stronger than expected, yet the country has failed to seize an opportunity to put its recovery on a sustainable path due to the absence of bold and long-lasting reforms, according to the Washington-based Institute of International Finance (IIF).
In a special report, the IIF noted that while Pakistan has successfully rebuilt its economic buffers and secured financing, the gains will likely prove short-lived without comprehensive structural reforms, particularly in tax broadening, privatisation, and the resolution of circular debt.
The report emphasised that Pakistan has made little headway in these critical areas, particularly privatisation and energy-sector restructuring, with circular debt still unresolved. The IIF warned that these unresolved issues pose a significant risk to Pakistan’s economic outlook for FY26.
Notably, inflation has decreased significantly, allowing the State Bank of Pakistan (SBP) to cut its policy rate to 11pc since the easing cycle began in June 2024.
In addition, Pakistan posted its first current account surplus (0.5pc of GDP) since FY11, along with the highest primary balance surplus (2.4pc of GDP) in over two decades in FY25. These developments have resulted in sustained multilateral and bilateral support and improved credit ratings.
However, the IIF highlighted that despite these positive headlines, the economic situation is not as promising as it may seem. Geopolitical tensions, both regional and global, pose significant challenges for FY26, while domestic political instability, though subsiding, remains fragile. The relationship between the military establishment and the opposition PTI party remains tenuous, adding to the uncertainty.
Highlights structural weaknesses in tax broadening, privatisation and energy sector, undermining long-term stability
While fiscal and external buffers accumulated in FY24/25 have provided some relief, they remain limited. The $5bn increase in reserve assets has boosted the country’s import coverage to just 2.4 months, while the primary balance surplus has led to a slight reduction in total public sector debt, which remains high at around 67pc of GDP. These figures suggest that while short-term stability has been achieved, long-term sustainability remains uncertain.
The IIF also pointed out that the recent trade agreement with the United States, Pakistan’s largest export partner, could provide some support to the textile industry, though the benefits are expected to be modest. Agriculture, which accounts for nearly a quarter of GDP and employs 40pc of the workforce, will likely remain sluggish. The kharif season, covering key crops such as rice, sugarcane, cotton, and maise, has faced early water shortages followed by heavy monsoon rains, which could weigh heavily on harvests in the first half of FY26.
Furthermore, deadly flash floods have exacerbated the challenges, plunging Pakistan into its second major flooding crisis in three years. This could have serious implications for growth, as well as for the country’s external and fiscal balances.
Inflation, while improving, remains a concern. A sharp rise in food prices, caused by the floods, led to a 2.9pc month-on-month increase in headline inflation in July, the largest increase in two years. Core inflation remains sticky, hovering around 7pc in urban areas and 8pc in rural areas. Additionally, energy price adjustments (including higher gas tariffs, subsidy removals, and increased fuel costs) and new tax measures are expected to feed into inflation in the near term. As a result, the SBP paused interest rate cuts in June and July, and the IIF expects interest rates to remain on hold for an extended period, with inflation averaging 6.5pc in FY26.
On the external front, the IIF forecasted that Pakistan’s current account will be influenced by the normalisation of imports (particularly machinery, raw materials, and consumer goods). Exports will depend largely on the progress of the US-Pakistan trade deal, though the IIF remains sceptical of its impact on exports. In the absence of a sharp increase in commodity prices, the current account deficit is expected to stay modest (about 0.5pc of GDP in FY26), allowing some reserve accumulation, though import coverage will remain critically low at about 2.5 months.
The IIF also expressed concerns over Pakistan’s fiscal situation. Although the country’s fiscal deficit narrowed to 5.4pc of GDP in FY25 and total revenues grew by 35.6pc, much of this growth came from one-off factors, such as record profits from the State Bank of Pakistan.
The Federal Board of Revenue (FBR) fell short of its target by about 1pc of GDP, and the federal tax-to-GDP ratio remains stuck at around 10pc. For FY26, authorities are forecasting another large increase in tax revenues, but this may be difficult to sustain given the already high tax burden on the formal sector and the exclusion of the retail/wholesale sectors, which account for about 20pc of GDP, from the tax net.
On the expenditure side, reductions in subsidies (particularly on electricity) and net lending to public enterprises have helped, but total spending still rose by 18pc in FY25. The IIF also noted that recent tensions with India could lead to an increase in defence spending in FY26.
As a result, the authorities’ targets of a 3.9pc of GDP deficit and a 2.4pc primary surplus for FY26 appear overly ambitious. The heavy reliance on domestic financing is also a cause for concern, and the IIF warned that fiscal performance will remain a key test for the IMF programme, with vested interests complicating the progress of reforms.
Published in Dawn, August 23rd, 2025