Pakistan’s latest budget has pushed defence spending above Rs 3 trillion for the first time, consuming 16% of federal expenses. The government is struggling with high debt servicing and limited room for development. For observers of the South Asian economy, this creates risks for long-term growth as the state continues to crowd out private sector credit to fund its fiscal deficit.
What Happened
Pakistan’s Federal Budget for the fiscal year 2026-27, which faced multiple delays, has been officially unveiled with a sharp focus on national security. For the first time, the country’s defence allocation has exceeded Rs 3 trillion, accounting for nearly 16% of the total federal expenditure. This budget sets the tone for the nation's economic strategy, emphasizing security-related outflows while struggling with significant fiscal constraints. While the government aims to comply with International Monetary Fund (IMF) conditions to maintain external financial support, the allocation reflects a prioritization of security infrastructure over industrial development.
The Scale of Defence Expenditure
The Rs 3 trillion defence budget does not tell the full story of the security establishment's economic impact. Defence pensions, which are substantial, are categorized under civilian expenditure at Rs 822 billion and are not included in this formal defence tally. When these costs are added, the actual burden on the state increases significantly. Furthermore, the military establishment maintains a presence in the commercial sector through institutions like the Fauji Foundation and the Army Welfare Trust. Policy decisions, such as fertilizer subsidies, often align with these entities, highlighting the deep integration of military-linked organizations within the broader economy. Projects like the Rs 925 billion allocated for civil works are also expected to benefit large contractors, many of whom have established ties with the defence sector.
Fiscal Reality and IMF Targets
On the fiscal front, the government is attempting to project stability to satisfy IMF requirements, including a primary surplus target of 2.0% of GDP. However, the numbers reveal a difficult situation. Debt servicing has become the single largest expense, consuming approximately 68.5% of the net federal revenue. This leaves very little room for investment in growth-oriented projects. To bridge the deficit, the government has set an ambitious tax target for the Federal Board of Revenue (FBR) at Rs 15,264 billion, relying heavily on digital tax enforcement. Additionally, the budget raises targets for the Petroleum Levy to Rs 1676.5 billion, a non-tax revenue stream that the federal government can utilize without needing to share funds with the provinces.
The Private Sector 'Crowding Out' Effect
A critical concern for long-term economic health is the 'crowding out' of private sector credit. Because the government is running a large operational deficit, it relies heavily on borrowing from domestic banks. By issuing high-yield, low-risk sovereign bonds, the state makes it more attractive for commercial banks to lend to the government rather than to private businesses. This effectively starves the private sector of the capital needed for expansion, innovation, and modernization. Consequently, export competitiveness suffers, and the country remains trapped in a cycle of low growth and high debt rollover requirements. Development spending has effectively remained flat at Rs 1000 billion in nominal terms, meaning investment in critical infrastructure is not keeping pace with inflation.
What Investors Should Track Next
Observers of the regional economy should watch for how the government manages its massive domestic debt pile. The key monitorables include the actual collection of tax revenues against the ambitious FBR targets and whether the government can avoid further cuts to development spending to meet its deficit goals. Additionally, the sustainability of the current debt-servicing ratio will be a major factor in assessing the stability of the economy, as any failure to roll over short-term debt could lead to further financial stress.