Pakistan

Water supply and insecurity will weigh on growth

The poor agricultural performance observed in 2025 could spill over into 2026, once again limiting the rebound in growth despite the positive effect of inflation falling back into single digits. The destruction of land during the 2025 floods, combined with further disruptions to India's water supply, are likely to continue to penalize agriculture. The sector employs 40% of the working population and accounts for a quarter of GDP. The Indian government's unilateral suspension of the Indus Waters Treaty in April 2025 effectively foreshadows further tensions for the sector. The decision was taken in retaliation for the terrorist attack in the state of Jammu and Kashmir attributed to a Pakistani jihadist organisation that killed 26 civilians, for which New Delhi holds Islamabad responsible. The treaty, which was signed in 1960 under the aegis of the World Bank, divides the use of the river's six tributaries between India, located upstream, and Pakistan downstream. Water from the basin irrigates 80% of Pakistani agriculture, making the sector particularly vulnerable to Indian decisions. Flooding during the monsoon and water shortages during the dry season could disrupt agricultural yields (rice, sugar cane, maize, cotton), raise costs and weaken food supplies, thereby increasing the need for imports. The energy sector would also be affected as one-third of the country's hydroelectric production depends on the Indus. The suspension of the treaty is therefore expected to partially revive inflation, which will nevertheless remain well below the levels seen in 2023 and 2024.

Improved access to credit, enabled by halving the key interest rate from 22% in 2024 to 11% in May 2025, and by IMF support, will bolster private consumption (80% of GDP). Large expatriate remittances will also contribute to this growth. Private investment will benefit from lower interest rates – which nonetheless remain high – but will continue to be thwarted by domestic instability (influence of the army, fragile coalition, terror attacks) and external insecurity (tensions with India and Afghanistan). Despite continued investment by Gulf countries in mining and maritime infrastructure, these are not expected to really take off. The completion of the TAPI (Turkmenistan, Afghanistan, Pakistan, India) gas pipeline, designed to transport Turkmen gas to Pakistan and India, appears to be compromised by tensions between these two countries. Second, construction of the Central Asia-South Asia (CASA1000) power line between Tajikistan, Kyrgyzstan, and Pakistan will continue gradually. Similarly, in 2025, China and Pakistan reaffirmed their commitment to relaunching phase II of the China-Pakistan Economic Corridor (CPEC), launched in 2013 and representing more than USD 60 billion in investments, mainly financed by Chinese commercial loans. This project aims to strengthen the country's regional and trade integration by connecting Kashgar in China's Xinjiang region to the Pakistani port of Gwadar on the Indian Ocean, and through the creation of special economic zones and the development of digital infrastructure. However, it has been subject to significant delays due to attacks by separatist groups in Balochistan and Pakistani budget constraints. These obstacles will remain in 2026.

Public spending will continue to be limited by tight budgetary margins. The contribution of exports to growth will be penalised by US customs duties (19% rate). Already weakened by the high cost of inputs on electricity and raw materials, the textile and clothing sector will be the first to be affected as it accounts for 80% of exports to the US, which is its largest trading partner.

IMF support provides reassurance amid fragile public and external accounts

During the 2024-2025 fiscal year, the public deficit was reduced and the primary surplus (excluding interest) increased (representing 2.5% of GDP) under the impetus of reforms supported by the IMF: broadening of the tax base, improvement in tax revenue collection, harmonisation of provincial income tax regimes with federal rules. Consolidation will continue during the 2025-2026 fiscal year, with the introduction of new taxes (agriculture, real estate, retail), the reduction of subsidies, and the gradual resumption of privatisation. However, revenues could underperform due to difficulties in the agricultural sector, the weight of the informal economy (accounting for 80% of the workforce) and widespread corruption. Overall expenditure is expected to decline, except for defence spending (excluding pensions), which will increase by 20% as a result of renewed tensions with India and the army's influence on the government. Significant military spending will thus absorb 19% of the federal budget (including pensions). Finances will remain burdened by debt servicing (20% of GDP, including amortisation and interest), with interest payments alone accounting for more than 44% of public revenues. The two ongoing IMF programmes will help Pakistan finance its deficit: a 37-month Extended Credit Facility and a 28-month Resilience and Sustainability Facility ending in September and July 2027, respectively. The total amounts are USD 7 billion and USD 1.3 billion, with the country having already received USD 3.3 billion. This continued support from the Fund reassures bilateral creditors, which account for 37% of external debt. Debt funded by China through official and commercial banks accounts for 28%. Domestic debt (64% of the total) is almost exclusively denominated in Pakistani rupees and accounts for 86% of total interest. Nearly half of this domestic debt consists of bonds held by local banks, which are themselves dependent on liquidity provided by the central bank.

In 2025, external accounts improved significantly thanks to large inflows of remittances from expatriate workers (9.5% of GDP) and the granting of funds from multilateral (IMF, World Bank) and bilateral creditors from China, Saudi Arabia, the United Arab Emirates and Kuwait. These transfers enabled the current account to post a slight exceptional surplus and foreign exchange reserves to be replenished to cover 2.5 months of imports.

These trends will continue in 2026, but without maintaining the surplus, due to a deeper trade deficit. Tensions over water management could increase dependence on food imports and affect cotton harvests used to manufacture textiles (clothing and linen), which account for 60% of the country's export earnings. Revenues will also be weakened by global trade uncertainty and the direct effect of tariffs imposed by the US administration. However, Pakistan is subject to a lower rate than some of its competitors: 19%, compared to 20% for Bangladesh and Sri Lanka, and 50% for India. Islamabad has negotiated a 10-point reduction in exchange for granting the US the right to exploit its oil reserves and a commitment to increase its energy imports from the country. The fall in the price of oil, which is the main import item, will curb the deepening of the deficit. Despite its desire to diversify its sources of financing, as evidenced by the issuance at the end of 2025 of its first yuan-denominated “Panda” bonds (USD 250 million), Pakistan will continue to depend on external aid to cover its small current account deficit and, above all, to service its debt.

Pervasive insecurity

Since the contested parliamentary elections in February 2024, the two traditional parties, the Pakistan Muslim League-Nawaz (PML-N) and the Pakistan People's Party (PPP), have been leading a fragile coalition alongside five other parties. Ranked second and third in the polls, respectively, and after days of negotiations, they agreed on a power-sharing formula to achieve an absolute majority and prevent the leading independent candidates from taking power. These independents were not allowed to run under the banner of the Pakistan Tehreek-e-Insaf or the Pakistan Movement for Justice (PTI), whose leader, former Prime Minister Imran Khan, has been imprisoned since August 2023 on multiple charges. The coalition is therefore operating in a climate of strong opposition, while its two main parties must overcome their own internal divisions, having alternated in power since the simultaneous independence of Pakistan and India in 1947. Prime Minister Shehbaz Sharif (PML-N) and President Asif Ali Zardari (PPP) must also contend with the influence of the army. Since 1947, the army has overthrown the government three times and directly ruled the country for more than three decades in total. Its Chief of Army Staff, Asim Munir, will retain his grip on defence and foreign affairs, invoking internal insecurity and tensions with neighbouring countries against the backdrop of the country possessing nuclear weapons. In November 2025, a constitutional amendment granted him lifelong immunity, extended his tenure until 2030, and expanded his powers by placing the air and naval forces under his command, in addition to the army.

Pakistan will continue to be targeted by large-scale terror attacks, which have become more frequent since the Taliban took power in Afghanistan in 2021. Islamabad accuses its neighbour of harbouring terrorist groups, notably Tehrik-e-Taliban Pakistan (TTP). Tensions peaked in October 2025, after a Pakistani military intervention in Kabul aimed at dismantling the TTP triggered bloody clashes along their border. Sporadic conflicts are likely to continue as Pakistan pursues the deportation of Afghan refugees. Balochistan, in the southwest, is also the target of attacks, this time by autonomous groups denouncing the lack of development and control over their mineral resources. These attacks fuel tensions between Iran and Pakistan, as the Baloch population is divided between the two countries. A resumption of hostilities with India is also to be feared. In May 2025, a ceasefire agreement ended the armed clashes triggered by an attack carried out by a Pakistani jihadist organisation in northern India. Despite the truce, bilateral relations will remain tense against a backdrop of persistent rivalries over Kashmir.

Pakistan will count on allies in the Gulf, notably Saudi Arabia, with which it signed a mutual defence pact in September 2025 and from which it will receive ongoing financial support. The country will maintain its economic and diplomatic ties with China, its main partner, while gradually strengthening its military and commercial cooperation with Bangladesh. This rapprochement, which began in early 2025 after the ousting of Sheikh Hasina Wajed's Bengali government, marks the first normalisation of diplomatic relations in 15 years and the first direct trade flow since Bangladesh's independence in 1971.

Last updated:November 2025