Spending cuts could slow medium-term growth, Fitch warns

ISLAMABAD: Fitch Ratings has cautioned that deeper-than-expected spending reductions, especially the continued squeeze on development expenditure, could weaken Pakistan’s medium-term growth outlook even as the country stays committed to fiscal consolidation under its International Monetary Fund programme.

In its review of the federal budget for FY27, Fitch said the government had set a primary surplus target of 2pc of GDP and an overall fiscal deficit target of 3.6pc of GDP. It said this followed what it described as a strong FY26 performance, with a projected primary surplus of 2.5pc of GDP, supported by sharp expenditure cuts and a provincial surplus of 1.1pc of GDP that was above its expectations.

Fiscal discipline and growth trade-off

The ratings agency said Pakistan’s efforts to narrow the deficit had relied heavily on reducing spending, particularly capital outlays, amid continuing revenue constraints. It noted that this approach had helped in the short term, but said it would be difficult to maintain over a longer period.

Fitch said persistently weak development spending could hurt economic expansion, reduce the scope for future revenue generation and make debt management more difficult. It added that room for further cuts was shrinking, increasing the tension between fiscal adjustment and growth as expenditure pressures begin to rise from a low base.

At the same time, Fitch said the continuation of fiscal consolidation had improved Pakistan’s near-term budget outlook. However, it added that the country remained exposed to inflation risks and possible shortfalls in tax collection, which is why its own fiscal projections were more conservative than the government’s estimates.

Revenue risks remain

According to Fitch, meeting the FY27 primary surplus goal will require tax revenues to continue outperforming historical trends, a difficult task given long-standing weaknesses in tax administration and a limited number of fresh tax measures. It pointed out that official projections show federal tax receipts in FY26 falling short of target by 0.7 percentage points of GDP, highlighting the difficulty of achieving ambitious collection goals.

It said the FY27 tax revenue target of 10.6pc of GDP would be a record for Pakistan, even though collections had improved in FY26. Fitch also noted that non-tax income, including transfers of profit from the State Bank of Pakistan, was expected to decline in FY27.

The agency said dependence on a sizeable provincial surplus was another uncertainty, citing the historical volatility of such balances and the coordination difficulties that often arise between the federal and provincial governments.

Debt and interest burden

Fitch said debt servicing costs remained structurally high because of Pakistan’s large volume of short-maturity domestic debt and elevated market yields. It added that any increase in the policy rate, if inflation rises on the back of higher global energy prices, could further increase the risk of overshooting interest expenditure.

It said the FY27 budget projected an interest-to-revenue ratio of 39.1pc, far above the 12.1pc median for countries rated in the ‘B’ category. According to Fitch, this significantly reduces fiscal space and limits room for priority spending, forming part of the weakness in Pakistan’s ‘B-’ sovereign rating with a stable outlook.

Fitch also said Pakistan’s overall fiscal deficit target of 3.6pc of GDP in FY27 remained above the 3pc median for ‘B’-rated peers.