Rebounding inflation, fiscal pressures threaten recovery

• Think tank says govt’s increasing reliance on borrowing from banking sector crowding out private investment
• Seeks policy shift to economic freedom, from reactive ‘stabilisation’ required by International Monetary Fund

ISLAMABAD: Pakistan’s nascent macroeconomic recovery, which began in 2025, is stalling due to the geopolitical situation, leading to rising inflation and reducing the monetary freedom of individuals and firms in an economy where around 80pc of the labour force operates in the informal sector.

“The macroeconomic recovery that began in 2025 is stalling due to geopolitical obstacles. CPI inflation re-entered double digits at 10.9-11.7pc between April and June, with the SPI climbing to 12.8pc by June, reducing the monetary freedom of individuals and firms,” said the Policy Research Institute of Market Economy (Prime), a private think tank, in its report for July 2026.

It stated debt servicing and defence consumed 94pc of net federal revenue, while in recent years defence spending had increased further, leaving just six per cent of revenue for health, education, infrastructure, social protection and all other essential government functions.

Prime highlighted that the Labour Force Survey 2025 reported that 80.8pc of the labour force was employed in the informal sector. A salaried individual earning Rs5 million faces an effective tax rate of 33.29pc, with tax deducted at source, leaving little scope for tax evasion. By contrast, a shopkeeper with the same income pays just 0.5pc under presumptive and fixed tax schemes. The Budget 2026-27 offered limited relief to the salaried class and did nothing to bridge this gap.

The report suggested that the policy response must shift from the reactive stabilisation required under the IMF programme to a resilience-driven framework that ensures economic freedom, defined as the fundamental ability of every individual to exercise control over their property and labour. In an economically free society, individuals have the right to work, produce, consume and invest as they choose.

Using the Heritage Foundation’s Index of Economic Freedom, Prime said Pakistan scored 48.9, placing it in the “Repressed” category. The index evaluates 12 quantitative and qualitative indicators across four pillars: Rule of Law, Government Size, Regulatory Efficiency and Open Markets.

While the index assigned Pakistan scores of 25.7 for property rights, 27.6 for judicial effectiveness, 26.3 for government integrity and 10.1 for fiscal health, Prime argued that even seemingly favourable scores concealed the actual situation. “Several scores conceal rather than reveal reality: Government Spending (88.5) and Tax Burden (78.2) suggest a lean, low-tax state; Pakistan is neither,” it observed.

The report noted that the National Tariff Policy 2025-30, a positive step for economic freedom, reduces customs duties on 3,125 tariff lines. In FY26, customs revenue increased from Rs1.588 trillion to Rs1.651tr despite the reduction in tariff rates.

According to the report, the recent budget provided some meaningful relief for salaried taxpayers, while the super tax was reduced, with its complete withdrawal for firms deriving 80pc or more of their revenue from exports. The income surcharge has also been eliminated. Likewise, the fiscal deficit is projected to narrow to 3.6pc of GDP, with a primary surplus of 2pc, although this is largely attributable to lower interest rates.

It highlighted that interest payments and defence account for 94pc of net federal revenue, leaving only 6pc for pensions, the running of the civil government and development spending combined. In addition, Rs2.353tr in tax expenditures demonstrated preferential treatment for selected sectors, funded through higher tax rates imposed on the documented economy.

It argued that Pakistan’s financial freedom score of 60.0 most sharply contradicted the ground reality. Credit to the government sector stood at Rs37.2tr in May 2026, compared with Rs13.8tr for the private sector. “A score for a financial system in which the government absorbs nearly three times more credit than the entire private sector does not reflect the reality of financial access in Pakistan,” the report said.

The report recommended lowering tax rates by broadening the effective tax base, reducing GST to 15pc, cutting the corporate tax rate to 25pc and abolishing the super tax. It also called for reducing the government’s borrowing footprint through differentiated bank capital adequacy treatment, legislating the National Tariff Policy’s 15pc customs duty ceiling and improving transparency by replacing the Petroleum Development Levy with a uniform GST rate, arguing that frequent changes in the PDL create uncertainty and reduce transparency for consumers.

Published in Dawn, July 27th, 2026 ...