Pakistan's Budget Deficit: A Structural Challenge

A budget deficit, defined as the excess of government expenditures over revenues within a fiscal year, is not inherently detrimental. In macroeconomic management, it can function as a counter-cyclical instrument, enabling public investment in infrastructure, human capital, and social protection, particularly during downturns or external shocks (IMF, 2023). When deployed within a credible medium-term fiscal framework, deficits can crowd in private investment and enhance long-run productive capacity. However, persistent and structurally embedded deficits, financed through excessive domestic borrowing or external debt accumulation, can generate inflationary pressures, currency depreciation, rising debt-servicing burdens, and diminished investor confidence. Pakistan exemplifies this fiscal paradox.

For several decades, Pakistan has faced a chronic structural imbalance rooted in a narrow tax base, low tax-to-GDP ratio, energy-sector subsidies, loss-making state-owned enterprises, and high defense and debt-servicing expenditures. Rather than being primarily cyclical, deficits have reflected entrenched revenue weaknesses and rigid expenditure commitments. During growth phases, fiscal expansion has often been pro-cyclical, amplifying macroeconomic overheating. Conversely, during downturns, revenue shortfalls and exchange rate pressures have widened deficits further, reinforcing vulnerability (Kemal, 2019).

Core economic institutions including the Ministry of Finance and the State Bank of Pakistan play pivotal roles in fiscal coordination and monetary stabilization. Repeated stabilization programs with the World Bank and the IMF have sought fiscal consolidation through tax reforms, subsidy rationalization, and structural adjustments. Yet implementation has frequently been constrained by political economy dynamics, weak administrative capacity, and reform fatigue. The resulting “stop-go” cycle, periods of adjustment followed by slippages, has undermined policy credibility and perpetuated reliance on external financing, limiting Pakistan’s fiscal sovereignty and long-term development planning.

Structural Determinants of Pakistan’s Persistent Budget Deficit

Pakistan’s chronic budget deficit is rooted in deep structural distortions rather than short-term cyclical imbalances. Foremost among these is persistently weak revenue mobilization. Pakistan’s tax-to-GDP ratio has hovered around 9–10 percent in FY2024, significantly below the Asia-Pacific developing economy average of approximately 15 percent (ADB, 2024). A narrow tax base, widespread informality, and heavy reliance on indirect taxation constrain revenue buoyancy. Only about 5.2 million individuals are active taxpayers in a population exceeding 240 million (FBR, 2024). The agricultural sector, contributing roughly one-fifth of GDP, remains lightly taxed due to constitutional divisions of power and entrenched political interests. Weak compliance enforcement, administrative inefficiencies, and pervasive tax evasion further erode fiscal capacity (Pasha, 2022).

On the expenditure side, fiscal rigidity compounds revenue weaknesses. Current expenditures dominate the budget, leaving limited room for development outlays. Large allocations to public sector wages and a structurally unsustainable pension regime impose recurring obligations. Untargeted subsidies particularly in energy and export sectors continue to strain the exchequer (Ministry of Finance, 2024). Defense spending, shaped by regional security dynamics, claims a significant share of resources. Most critically, debt servicing has become the single largest expenditure component.

The debt overhang represents a self-reinforcing constraint. By FY2024, interest payments consumed over half of total federal revenues (Ministry of Finance, 2024). This creates a classic “snowball effect,” wherein borrowing to finance past deficits raises future interest obligations, perpetuating a cycle of fiscal stress (Khan, 2023). Pakistan’s exposure to domestic interest rate fluctuations and external financing conditions heightens vulnerability, as new borrowing increasingly finances debt rollover rather than productive capital formation.

The energy sector constitutes another structural fault line. High generation costs, transmission and distribution losses averaging 16–18 percent, and tariff distortions have generated persistent circular debt. By mid-2024, accumulated liabilities in the power sector exceeded Rs. 2.6 trillion (SBP, 2024). Government bailouts to stabilize state-owned energy enterprises directly inflate the fiscal deficit, crowding out social and infrastructure spending.

Political economy constraints further impede reform. Influential interest groups resist broadening the tax net or rationalizing subsidies (Ahmed & Mustafa, 2021). Short electoral cycles incentivize expansionary, populist fiscal measures while discouraging structural adjustments that yield benefits beyond a single term. Policy discontinuity and frequent government transitions undermine credibility and investor confidence.

Finally, structural external vulnerabilities exacerbate fiscal fragility. Pakistan’s import-dependent economy is highly sensitive to commodity price shocks. Global energy and food price surges following the Russia-Ukraine conflict intensified subsidy burdens and widened the current account deficit (World Bank, 2023). Additionally, catastrophic climate events (most notably the 2022 floods causing over $30 billion in damage) necessitated substantial unbudgeted expenditures (UNDP, 2022). Collectively, these structural weaknesses entrench fiscal imbalances, rendering deficit reduction contingent upon comprehensive and sustained institutional reform rather than temporary stabilization measures.

International Dimensions of Pakistan’s Fiscal Imbalance

Pakistan’s persistent budget deficit carries substantial international implications, shaping its engagement with multilateral lenders, global capital markets, and currency dynamics. Foremost is its recurrent reliance on stabilization programs with the International Monetary Fund. In July 2023, Pakistan entered its 24th IMF-supported arrangement, underscoring a long-standing dependence on external balance-of-payments support. These programs typically require fiscal consolidation through enhanced revenue mobilization, rationalization of expenditures, energy tariff adjustments, and a market-determined exchange rate regime (IMF, 2024). While IMF financing provides critical liquidity and serves as a policy credibility anchor, often unlocking additional funding from bilateral and multilateral partners, it also entails austerity measures that can suppress short-term growth and provoke domestic political resistance. The cyclical pattern of program entry, partial compliance, and renewed distress has reinforced perceptions of structural fragility.

Chronic fiscal deficits and rising public debt also directly affect sovereign creditworthiness. International rating agencies such as Moody's, Fitch Ratings, and S&P Global Ratings evaluate Pakistan’s repayment capacity based on fiscal sustainability metrics, external buffers, and political risk. Pakistan’s ratings have frequently remained near speculative or “junk” status, elevating sovereign risk premiums. Consequently, access to international bond markets becomes constrained and borrowing costs escalate. This creates an adverse feedback loop: deficits necessitate external borrowing, yet deteriorating credit metrics make such borrowing increasingly expensive and limited, discouraging foreign direct investment and portfolio inflows (Fitch Ratings, 2024).

Large fiscal imbalances further contribute to exchange rate vulnerability. Heavy reliance on external financing increases foreign currency liabilities and heightens rollover risk. When investor confidence weakens due to concerns over debt sustainability, capital outflows intensify, placing downward pressure on the Pakistani rupee (SBP, 2024). Currency depreciation inflates the domestic cost of servicing external debt and raises import prices, particularly for energy and essential commodities, thereby exacerbating inflationary pressures and widening subsidy burdens. Thus, Pakistan’s fiscal deficit is not merely a domestic accounting imbalance but a structural determinant of its international economic standing.

Macroeconomic and Social Consequences of Persistent Fiscal Deficits

Pakistan’s sustained fiscal imbalances have generated profound macroeconomic distortions and adverse social outcomes. One of the most immediate macroeconomic consequences is inflationary pressure. When fiscal deficits are monetized, effectively financed through central bank liquidity creation, they expand the monetary base and intensify demand-side inflation. Although the State Bank of Pakistan has strengthened its institutional autonomy and adopted inflation-targeting frameworks, historical episodes of fiscal dominance have constrained its capacity to maintain price stability (SBP, 2023). Inflation averaged above 29 percent in FY2023, severely eroding purchasing power, compressing real wages, and disproportionately harming fixed-income households. High inflation volatility also heightens uncertainty, raises risk premiums, and discourages long-term private investment.

A second critical channel is the crowding-out effect. Heavy government borrowing from domestic commercial banks absorbs a significant share of available loanable funds. In FY2024, public sector borrowing remained elevated, limiting credit allocation to private enterprises (SBP, 2024). This distortion reduces capital formation in productive sectors, suppresses entrepreneurship, and weakens employment generation. Over time, diminished private investment undermines total factor productivity and constrains potential GDP growth.

Persistent deficits also compress development expenditure. As debt servicing and recurrent expenditures consume a growing share of revenues, allocations to the Public Sector Development Program decline. In FY2024, development spending constituted less than 15 percent of total expenditure (Ministry of Finance, 2024). Chronic underinvestment in infrastructure, education, and healthcare impairs human capital accumulation and long-run competitiveness. In essence, current consumption is financed at the expense of future prosperity.

The social ramifications are equally severe. Regressive taxation structures and inflation disproportionately burden lower-income households, widening inequality. Underfunded public services weaken social mobility and perpetuate intergenerational poverty. Moreover, constrained investment in labor-intensive and high-growth sectors contributes to elevated youth unemployment in a demographically young society. Prolonged economic stress can exacerbate social tensions and erode institutional trust, reinforcing a cycle of fiscal fragility and governance challenges.

Pathways Toward Sustainable Fiscal Consolidation

Achieving fiscal sustainability in Pakistan necessitates a coherent medium-term adjustment strategy anchored in structural reform rather than episodic stabilization. Central to this effort is broadening the tax base. Comprehensive reforms must prioritize documentation of the informal economy, integration of retail and agricultural income into the tax net, rationalization of exemptions, and simplification of compliance procedures. Leveraging digitalization such as data integration, e-invoicing, and risk-based audits can strengthen enforcement and reduce evasion (FBR, 2024). A shift toward progressive direct taxation would enhance equity while improving revenue buoyancy.

Expenditure rationalization is equally critical. Untargeted subsidies, particularly in energy and commodity markets, should transition toward targeted, means-tested cash transfers. Programs such as the Benazir Income Support Program demonstrate how social protection can be preserved while reducing fiscal leakages. Simultaneously, reforming and restructuring loss-making state-owned enterprises is essential to halt recurrent quasi-fiscal losses (Ministry of Finance, 2024). Transparent governance frameworks, professional management, and selective privatization can alleviate long-term fiscal pressures.

Institutional strengthening underpins all reforms. Enhancing public financial management systems, digitizing expenditure tracking, and reinforcing anti-corruption oversight mechanisms would improve allocative efficiency and restore investor confidence. Finally, durable fiscal consolidation depends on sustained growth. A strategy focused on export diversification, productivity enhancement, and foreign direct investment, supported by structural reforms and regional trade integration, can expand the revenue base and foreign exchange earnings (ADB, 2024). Fiscal sustainability, therefore, requires synchronized reforms across revenue mobilization, expenditure discipline, governance, and growth strategy.

Conclusion

Pakistan’s budget deficit is not merely a recurring fiscal imbalance but a manifestation of deep structural weaknesses embedded in the country’s political economy and institutional architecture. While deficits can serve as legitimate macroeconomic tools when strategically deployed, Pakistan’s experience demonstrates the risks of persistent, debt-driven financing unsupported by adequate revenue mobilization and expenditure discipline. A narrow tax base, rigid current expenditures, mounting debt-servicing obligations, energy-sector inefficiencies, and vulnerability to external shocks have collectively entrenched fiscal fragility. The consequences extend beyond accounting metrics, distorting monetary policy, fueling inflation, crowding out private investment, compressing development spending, and exacerbating inequality and social vulnerability.

Repeated stabilization efforts have provided temporary relief but have not fundamentally altered the structural drivers of the deficit. Sustainable fiscal consolidation will require political commitment to broaden the tax net, rationalize subsidies, reform state-owned enterprises, strengthen governance, and foster export-led growth. Without such coordinated reforms, Pakistan risks remaining trapped in a cycle of borrowing, adjustment, and renewed crisis. Conversely, decisive structural transformation can convert fiscal policy from a source of instability into a foundation for inclusive growth and long-term economic resilience.

References: Ahmed, & Mustafa; ADB; FBR; Fitch Ratings; Husain; IMF; Kemal; Khan; Ministry of Finance; Pasha; SBP; UNDP; World Bank.

Please note that the views expressed in this article are of the author and do not necessarily reflect the views or policies of any organization.

The writer is affiliated with the Institute of Agricultural and Resource Economics, University of Agriculture, Faisalabad. Pakistan and can be reached at gondalashir6@gmail.com

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