Reserve R1 — Pakistan's Economy: Stabilisation or Debt Trap?

Reserve question: "Pakistan's economy has stabilised, but it has not yet started to grow." Critically evaluate this statement with reference to the FY2026–27 budget and the IMF programme, and propose a strategy for sustainable growth. (20)

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Why it is likely: the economy was asked in 2016, 2019, 2020, 2023 and 2025, and as "fiscal stress" in 2026, roughly every year or two. The FY27 budget (debt servicing larger than defence and development combined) plus the 2026 energy shock make it highly topical. Probability: high.

What the examiner wants

• Critically evaluate the statement: evidence of stabilisation vs absence of growth
• Use FY27 budget and IMF facts
• A strategy for sustainable growth
• Marks split: stabilisation evidence ~4 · why growth is weak (structural) ~7 · 2026 shocks ~2 · strategy ~6 · conclusion ~1

Outline

• I. Introduction: largely agree
• II. Evidence of stabilisation (2023–26)
• III. Why growth hasn't followed
  1. The debt-servicing trap
  2. Narrow tax base
  3. Low investment and exports
  4. Energy costs and circular debt
  5. Loss-making state enterprises
  6. Human capital and the youth bulge
• IV. 2026 shocks: energy crisis and security
• V. Strategy for sustainable growth
• VI. Conclusion

Model Answer

I. Introduction

• Since the near-default of 2022–23, Pakistan has regained macroeconomic stability under IMF discipline. But growth remains around 3–4%, too low to absorb a fast-growing workforce.
• Thesis: the statement is largely accurate. Stabilisation was achieved mainly by squeezing demand and imports, not by fixing the structural causes of low growth. The FY2026–27 budget shows the trap: debt servicing is the biggest expense, leaving little room for investment.

II. Evidence of stabilisation

• Inflation fell from near 38% (May 2023) to single digits; the policy rate was cut sharply from 22%.
• A current account surplus in FY2024-25, helped by record remittances (about $38 billion).
• IMF programmes: a $3 billion SBA (2023), the **$7 billion EFF (2024)** and a $1.4 billion RSF (2025), with reviews completed and a primary surplus maintained.
• The FY27 budget targets a fiscal deficit of 3.6% of GDP and a 2% primary surplus.

III. Why growth hasn't followed

• 1. The debt-servicing trap
  • In the FY27 budget (Rs 18.77 trillion), debt servicing is about Rs 8.05–8.1 trillion, more than defence (Rs 3 trillion) and the federal PSDP (Rs 1 trillion) combined.
  • Most federal revenue pays for past borrowing.
• 2. Narrow tax base: tax-to-GDP of about 10–11%. The burden falls on salaried and formal sectors, while retail, agriculture income and real estate are under-taxed. The FBR target is about Rs 15.26 trillion.
• 3. Low investment and exports:
  • Investment of about 13–14% of GDP; FDI under 1% of GDP.
  • Exports of about 10% of GDP, mostly low-value textiles.
• 4. Energy: expensive power and circular debt make industry uncompetitive.
• 5. State-owned enterprises: large annual losses; PIA's privatisation (2025) is a first step.
• 6. Human capital: about 26 million out-of-school children, stunting, and low female labour participation.
• The boom-bust pattern: every growth spurt above 4–5% widens the current account deficit, triggering another crisis (the Thirlwall constraint).

IV. 2026 shocks

• The Hormuz energy crisis raised fuel prices about 40% in a month (April 2026), forcing austerity and a four-day week.
• Security costs: the defence budget was up about 15.6%, alongside the Afghan conflict and terrorism in KP and Balochistan.
• Political instability (the KP emergency, October 2026) hurts investor confidence.
• Positive openings: critical-minerals deals with the US, Gulf investment through SIFC, the IT sector, and a possible US exchange-stabilisation facility.

V. Strategy for sustainable growth

1. Tax the untaxed: retail, agriculture income and property, through digital tracking; cut exemptions worth trillions.
2. Reduce debt costs: longer maturities, refinancing, and lower interest rates as inflation falls.
3. Export-led growth:
   • A competitive exchange rate and energy tariffs for exporters.
   • Tariff rationalisation (the National Tariff Policy 2025–30).
   • Diversification into IT, engineering, minerals processing and agri-food.
4. Energy reform: renegotiated IPP contracts, privatised distribution companies, and local renewables.
5. State enterprise reform: privatisation and professional boards.
6. Invest in people: education, health and skills; women in the workforce.
7. Policy continuity: a Charter of Economy agreed across parties, so reforms survive political crises.
8. Climate resilience: protect growth from floods and heat.

VI. Conclusion

• Pakistan has climbed back from the edge of default, which is a real achievement.
• But stability bought by import cuts and IMF discipline isn't the same as prosperity. Unless Pakistan broadens its tax base, cuts its debt burden and builds an export economy, the next shock (an oil spike, a flood, a political crisis) will push it back into the same cycle.

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Key facts to memorise (FY27 budget)

• Outlay: Rs 18.77 trillion. GDP growth target: 4%. Inflation: about 7.5–8.2%.
• Debt servicing: about Rs 8.05–8.1 trillion. Defence: Rs 3 trillion. Federal PSDP: Rs 1 trillion.
• FBR target: about Rs 15.26 trillion. Deficit: 3.6% of GDP. Primary surplus: 2%.
• BISP: Rs 838 billion. Minimum wage: Rs 40,700.