Israel and the US attacked Iran on 28 February, with a primary goal of regime change. Iran retaliates hard, and the regime stands strong;
Iran’s asymmetrical strategy is to expand the war (to the GCC, Iraq, and Lebanon), keep oil prices elevated to increase the cost of this war, and weaken US support for this war of choice. Now, Iran wants the US to close its military bases in the region;
The US has told Israel not to target Iran’s hydrocarbon infrastructure for fear of further spiking oil prices. However, since Israel’s goal is to destabilize the region and doesn’t care much for oil prices, it has targeted Iran’s oil and gas facilities. Iran has retaliated in kind in the GCC and has also blocked the Straits of Hormuz. Brent crude has touched $118/b, and has averaged above $100/b since the war started;
With mounting anger within the US against this war, Iran’s strategy is to take the military blows and keep oil prices elevated to the point that Trump throws in the towel;
The peace and tranquility in the GCC have been shattered, especially in Dubai, which has had to bear the brunt of Iran’s retaliation. Iran’s goal is to prove to its neighbors that the US security umbrella for the GCC is ineffective;
We expect the conflict to end in the first half of April, as Trump loses the political will to continue. Knowing him, he will declare victory and take his military machinery to the Caribbean;
GoP acted quickly by increasing fuel prices by Rs 55/l for both petrol and diesel. It has also implemented emergency measures like the 4-day week, online schooling, work from home, and monitoring petrol stations across the country;
This hike will spike food inflation, and could increase average headline inflation in FY26 from 7.2 to 8.7%. This opens up the possibility that SBP may increase interest rates in the remaining months of FY26 to increase its profits, which have become a key source of GoP’s non-tax revenues;
We disagree with the dire assessment of the Iran war on Pakistan’s economy. We argue that Pakistan’s hidden upsides have kept the FX market stable since August 2025, and will remain in play. Even two weeks into the war, SBP’s FX reserves continue to increase, and the rupee continues its gradual appreciation;
Remittances from the GCC could take a hit in the next couple of months. However, part of the hidden upside is that Pakistani labor could be given priority in the GCC in the post-war security arrangement;
The 3rd review of the EFF has been postponed. Media reports claim that the IMF is not satisfied with the follow-through on energy and fiscal reforms, while the GoP has repeatedly rejected the IMF’s efforts to implement sensitive institutional reforms. In a war scenario with Pakistan’s hidden upsides, the EFF is becoming irrelevant and is unlikely to be completed;
The war between Afghanistan and Pakistan has escalated. However, we are optimistic that with China now mediating, hostilities will soon end.
Media sources claim the IMF mission will focus on the Governance & Corruption Diagnostic (GCD) recommendations, and emphasize the provincial government’s commitment to the National Fiscal Pact (NFP);
We think the GoP isn’t interested in the GCD’s demands, while it has utterly failed to expand the tax base. The NFP is a critical understanding under which the provinces agree to transition away from the NFC awards and begin collecting taxes that fall within their jurisdiction (e.g., taxes on agriculture, retail and wholesale trade, property transactions, and real estate developers);
We expect both the Center and the IMF to pressure the provincial governments to curb their spending (esp. PSDP) and focus on expanding the tax base. We expect provincial governments to push back, as such taxes will directly impact the core supporters of PPP and PML-N;
The end-December fiscal targets will also be discussed. The three targets that were met can be traced to abnormally high SBP profits and generous NFC awards to the provinces – this goes against the spirit of the EFF. Furthermore, the two targets that were missed (FBR revenues and income tax on retailers) are directly linked to the GoP’s failure to expand the tax base. The latter means a disproportionate burden on the salaried class;
With such fundamental shortfalls, we have our doubts the GoP will be able to complete the EFF as scheduled by September 2027;
The IMF may also take exception to a recent statement by SBP’s Governor that elevated interest rates guarantee strong SBP profits, which has become a major source of federal non-tax revenues;
January posted a current account surplus of $ 121 mln, but the 7-months of FY26 show a deficit of $ 1.1 bln. The IMF may also ask SBP to explain the gradual appreciation of the rupee since July 2025;
SBP’s FX reserves continue to show a steady weekly increase, despite the underlying CA deficit and ongoing debt repayments. The week ending 13th February shows an increase of $ 19.1 mln, even though SBP repaid $ 700 mln in the preceding week to a Chinese commercial bank. The disconnect between underlying fundamentals and key external parameters will also raise questions from the IMF;
In view of these points, the negotiations with the IMF are likely to be tense;
IK’s ill health has energized the PTI and gained global attention. This paints a poor picture of the Hybrid government;
Terrorist incidents have become a daily occurrence and are increasingly deadly. GoP has threatened Afghanistan with direct air strikes if these attacks continue;
The US appears poised to attack Iran. Netanyahu is eager for regime change in Iran, and Trump has been hinting at it as well. With two carrier strike forces in the region, the momentum for war is building. This will destabilize the region and spike global oil prices, which means Pakistani consumers will suffer;
We also anticipate US pressure on Pakistan to commit troops for Trump’s Board of Peace. This will be deeply unpopular in Pakistan.
The status quo in the economy remains despite growing pressure to grow the stabilized economy;
The rupee continues its gradual appreciation, as SBP’s FX reserves keep rising in a measured manner;
This is so despite the vastly different BoP positions; the 1H-FY26 CA deficit was $ 1.2 bln, while 1H-FY25 posted a CA surplus of $ 957 mln;
The sharp cut in retail diesel prices has further reduced our average inflation projection for FY26 from 7.0% to 6.4%, which creates space for more rate cuts: we expect a 50-bps rate cut on 26th January;
SBP’s unorthodox monetary policy (injecting massive liquidity into the system while entering an easing monetary policy cycle) goes against IMF policy advice; we argue this is one of several divergences from the EFF roadmap that was released in December;
The PM launched the Economic Governance Reforms on the last day of the IMF deadline. However, the event was more about GoP’s achievements on the economic front than a call to action about the tough institutional reforms ahead. In our view, the launch lacked commitment;
The return to older promises to double exports, reduce power tariffs, ease the cost of doing business, and provide relief to the people, suggests that the GoP does not have a plan for the economy. Perhaps this is the interim stage before a more significant shift towards growth is announced, which will require some sort of understanding with the IMF;
Media coverage and analysts have fixated on Pakistan’s military exports. While details are sketchy, public interest will pressure the authorities to share more. Perhaps this could be the pretext to talk to the IMF about changing the direction of the EFF, or consider an early exit from a program that appears to have stalled;
The most significant developments are global, specifically the series of unilateral actions taken by the US in the first two weeks of 2026. From attacking Venezuela, claiming its oil fields, and taking charge of its oil shipments, to threatening Iran with military strikes, and finally, Trump’s decision that he wants to own Greenland even if that means undermining NATO, the EU, and the special relationship with the UK;
Much of this was hinted at in November when the White House released the National Security Strategy paper, but few thought it would result in such immediate actions;
While Trump has effectively upended the global order, he has suddenly created a bipolar world order. While Pakistan, like all other countries, must be careful about its next steps, this global turmoil helps Pakistan fortify its role as a security provider in the Middle East region.
The 3rd EFF tranche has been released, along with the Governance & Corruption Diagnostic (GCD) assessment. Waivers were secured for several end-June 2025 targets that were missed;
The GCD assessment includes 15 priority actions that GoP will have to implement according to a schedule that will be announced soon. These require institutional reforms in FBR, SIFC, SECP, PSDP, the Auditor General’s office, CCP, NAB, and other oversight bodies;
Despite expectations that Pakistan could shift towards a growth phase, the IMF’s revenue targets have not changed, while the primary surplus target has increased by Rs 1.1 trn. This means full fiscal austerity in FY26;
SBP surprises the market by cutting the discount rate by 50 bps on 15 December, which goes against IMF advice contained in the December Staff Paper (SP). This also means SBP’s monetary policy is at odds with MoF’s fiscal policy;
There is growing concern about the rupee’s gradual strengthening, with analysts talking about Pakistan’s Dutch Disease. With no concessions on IMF conditions that have angered the textile and auto sectors, SBP’s exchange rate policy may have to change;
November posts a current account surplus of $ 100 mln. However, the cumulative CA deficit continues to increase, indicating that past CA data have been revised in the past month. We remain concerned about SBP’s BoP data, especially given the counterintuitive impact of the CA balance on SBP’s reserves and the rupee parity in FY25 (when Pakistan posted a full-year CA surplus of $ 1.9 bln) and the first 5 months of FY26 (with a CA deficit of $ 812 mln);
November’s inflation data also surprised us and forced us to revise our inflation projections for the year. The IMF has also reduced its average inflation projections from 7.7 to 6.3%, while we have reduced ours from 8.5 to 7.0 %;
With economic policies appearing to work at cross purposes, and senior GoP members advocating for growth, we seek clarity on where the country is heading;
We anticipate pressure from big businesses and politicians against the IMF’s fiscal austerity;
The most optimistic scenario is that a deal can be struck whereby the GoP commits to difficult institutional reforms (listed in the GCD report) in exchange for some fiscal leeway.
The approval of the 2nd tranche is scheduled for Dec 8. While we do not expect any surprises, we will look closely at key targets for FY26 and FY27 to gauge if the EFF is more supportive of economic growth;
The Governance & Corruption Diagnostic (GCD) assessment is a prior action. After the 26th and 27th Amendments, the unchecked power of the Executive may raise some eyebrows;
As discussed earlier, the performance criteria have become easier even as quarterly targets have not changed. The primary surplus target and SBP’s FX reserves are no longer challenging;
The steady and consistent increase in weekly SBP reserves since 1st August is suspicious, especially since the 4-month CA deficit is $ 733 mln compared to a deficit of $ 206 mln last year. The fact that the rupee has been gaining strength since the 3rd week of July 2025 is also surprising;
Monthly remittances remain strong, with October posting an inflow of $ 3.4 bln. This should easily exceed the $ 38.3 bln realized in FY25;
Given the rupee’s ongoing strength, we have revised down our rupee-$ parity for the remaining months of FY26. Furthermore, since Russia is scaling up its attacks on Ukraine, while the US looks poised to attack Venezuela, we have upped our projections for global oil prices. Since these two forces counteract each other, our average inflation for FY26 remains around 8.5%;
With projected YoY inflation likely to increase till the end of FY26, we do not see any change in the benchmark interest rate in FY26;
The 27th Amendment further curtails the independence of the Supreme Court, which means the executive has all the power; the legislature has lacked credibility from the start. With an extended 5-year term for military chiefs, and lifetime immunity from prosecution for Field Marshall Munir, the Establishment has become the senior partner in the Hybrid government;
With Pakistan’s leadership frequently boasting about the country’s economic stability, we raise the possibility that after the concentration of power in the executive (i.e., the Establishment), whether GoP may embark on an economic growth phase. This may contradict the thrust of the EFF, but with the comfort in the external sector and stagnant growth since FY23, it is a tempting option;
How the government manages the public’s reaction to these constitutional amendments remains to be seen, but higher economic growth will certainly help;
There is still no clarity about the role of the Pakistan military in Gaza. However, if this is the source of the inexplicable improvement in Pakistan’s external sector, it will support the government’s desire to enhance economic growth and prosperity.
The Staff Level Agreement (SLA) is done after an inconclusive mission. The two parties had different views on the impact of the floods on FY26 projections. It would appear that the IMF has prevailed, as pre-flood targets have been accepted;
SBP’s Annual Report FY25 was released a day after the SLA announcement. The central bank’s assessment has highlighted the risks for key macro projections like GDP growth, inflation, and Pakistan’s BoP, but it retains the pre-flood annual targets, and has an ambitious fiscal deficit goal of 3.8-4.8% of GDP;
CA surplus of $ 110 mln in September surprises many, but the 1Q-FY26 external deficit is still $ 594 mln;
There are concerns about Pakistan’s BoP data and net SBP FX reserves. There is a large discrepancy between PBS and SBP’s trade deficit data for September, while the consistent buildup in net SBP reserves does not tally with the BoP reversal in 1Q-FY26 and Eurobond repayment in end-September;
The PKR continues to gain strength, which suggests active management by SBP (intervention and/or moral suasion);
Interest rate expectations have settled, with most analysts predicting a status quo for the foreseeable future;
The IMF’s Staff Paper, which is released at the time of the 2nd tranche, is awaited but could be delayed. The fate of hard structural reforms (↑ tax base, SOE, and energy sector reforms) will be revealed when the Staff Paper is released;
Trump’s Gaza peace plan is signed with much pomp and ceremony, but the next steps are vague. Details of the International Stabilization Force are awaited, as it is expected that Pakistan’s army could play a pivotal role;
The conflict in Ukraine is likely to be settled in Putin’s favor. Trade tensions have increased between China and the US, while the latter is resorting to authoritarian measures to manage public protests in the US.
The IMF review mission begins on 25th September, starting with SBP;
Media reports claim that SBP’s operational independence, the lack of progress on SOE reforms, failure to expand the tax base, and a missed structural benchmark on corruption and governance, will be sore points;
However, the floods are likely to dominate media coverage, changing fiscal targets and BoP projections;
The 2-month CA Deficit hits $ 624 mln, but the rupee continues to gain strength. Soft oil prices will help Pakistan, but the impact of the floods on imports and exports is likely to be severe;
SBP maintains the status quo on its monetary policy, and this is likely to remain until revised inflation projections are released. We maintain our average inflation projection of 8.2% for FY26;
Pakistan’s debt is not as alarming as recent media reports. However, the acute dependency on bank financing reveals a structural problem;
Pakistan and Saudi Arabia signed a Strategic Mutual Defence Agreement a few days back. Details are lacking, but domestic and global media are touting this as a significant development. Providing a security umbrella to Saudi Arabia (and the rest of the GCC) should earn Pakistan hard currency (export of military hardware and services). However, official secrecy will make it very difficult to gauge the positive impact on Pakistan’s BoP; &
Netanyahu has not lost the plot, but is changing the global story. His attack on Doha and invasion of Gaza City have made Israel an international pariah and weakened America’s global standing. We see the Saudi defence pact as just another step in a changing global order.
There is some concern with the EFF after missed revenue targets (end-June), and concerns raised by the IMF about governance issues (e.g., beneficial owners of companies, money laundering checks) and the need to change the SBP Act;
Abnormal SBP profits surrendered to GoP in FY25 (Rs 2.6 trn), allowed the government to overachieve on the fiscal deficit target despite the tax revenue shortfall;
Giving up on documenting traders and businessmen, while placing a heavier burden on the salaried class, will not be appreciated by the IMF;
SBP surprises the market by not cutting interest rates. This may have been done because the next day, PBS data showed that YoY inflation had increased from 3.2% to 4.1%;
SBP releases data on its net purchases of $s on its website. For the period from June 2024 to April 2025, SBP purchased $ 7.2 bln. In our view, this is the reason the rupee started depreciating in the last two months of FY25;
Ratings agencies have upgraded Pakistan’s sovereign ratings, which makes it more likely that GoP will tap into global capital markets in FY26;
The rupee started gaining strength on 23 July, as the authorities clamped down on exchange companies and currency smuggling. While the rupee still remains strong, this goes against the reversal in Pakistan’s BoP;
Against a CA surplus of $ 2.1 bln in FY25, July’s CA deficit was $ 254 mln. With the IMF projecting a full-year CA deficit of $ 1.5 bln in FY26, SBP will have to manage expectations in the FX market as Pakistan’s BoP position reverses;
Monsoon rains across the country have killed over 700 people and devastated infrastructure in GB and KP. Pakistan’s inability to manage extreme weather conditions means it is ill-equipped to handle climate change. The IMF’s climate resilience program will help, but this requires smooth sailing with the underlying EFF;
The massive reconstruction needed to repair the flood damage could undermine the fiscal austerity of the EFF; &
What we have in Pakistan is economic stability without structural reforms, promises of future prosperity, and no clear roadmap for the economy.
Traders’ strike reveals a disconnect between the federal government and the provincial and local governments. We expect a compromise that will have to be sold to the IMF;
The sharp increase in fuel prices in July has upped our average inflation projection to 11.2% in FY26. Revenue focus will have a regressive impact on the people;
If our inflation projection is correct, this opens up the possibility that interest rates could be increased in FY26;
Breaches in end-June targets and structural benchmarks will be discussed and finalized in mid-September during the second biannual IMF review. We expect headwinds in our negotiations with the IMF;
Pakistan’s BoP posts a $ 2.1 bln CA surplus in FY25, with a $ 328 mln CA surplus in June. The swing factor was a record-breaking remittance inflow of $ 38.3 bln last fiscal year;
GoP has withdrawn the incentive scheme on remittances in FY26. A senior source in SBP has cautioned that this could reduce remittances to pre-FY24 levels;
With a rising trend in non-oil imports and an expected reversal in Pakistan’s BoP in FY26, the rupee is weakening. With low domestic interest rates, there is a growing risk of $ization;
GoP appears to have lost the appetite for structural reforms. After two years of stagnant economic growth and the likely spike in inflation, the political costs are perhaps too high to remain committed to past promises made to the IMF;
The judiciary hands the government a 2/3 majority at the center by allocating reserved seats to the ruling coalition government. With the hybrid arrangement solidified in favor of the Establishment, the shift toward authoritarian control of the country is intensifying.
The IMF drives FY26 Budget’s austerity, which is tax revenue-driven. Some concessions have been made as GoP tries to secure parliamentary approval;
Consolidated fiscal deficit target is 5% of GDP, and growth is projected at 4.2%; both are ambitious targets. This requires large surpluses from the provinces and a 19% increase in FBR revenues. However, with slower growth and inflation in FY26, revenue targets will be challenging;
SBP’s 5-7% average inflation range is unhelpful, while the IMF’s 7.7% projected inflation is too high. If average inflation is around 5% (our tentative prediction), the market will expect interest rate cuts in FY26;
The Budget seeks to financially isolate Non-Filers, who will not be allowed to buy or sell autos and real estate, will not be able to operate bank accounts, and cannot invest in financial instruments. After the failure of the Tajir Dost scheme, penalties against Non-Filers seek to force them to be documented;
The EFF and the government’s power policy is to focus on full cost recovery. This will fail as cheaper solar power options will be adopted, even though the authorities are trying to discourage renewable energy. Pakistan’s power sector needs a radical rethink;
Tariff rationalization as part of the five-year program seeks to make Pakistan’s economy more competitive. This will hurt local manufacturing, specifically textiles, autos, and other protected sectors. It will also make Pakistan’s BoP more challenging in FY26;
This will further complicate SBP’s net international reserves (NIR) targets in the EFF;
Israel’s surprise attack on Iran (13 June) was designed to scuttle US-Iran nuclear talks. Both countries continue to strike each other, but Israel has the upper hand, as it controls Iran’s airspace;
Trump invites Field Marshal Munir to the White House for an unprecedented, cozy meeting. FM Munir may have warned Trump against attacking nuclear sites, as it would set a dangerous precedent. Pakistan then nominates Trump for the Nobel Prize;
The next day Trump says he will decide in two weeks whether the US will join Israel to target Iran’s nuclear facility, which is Netanyahu’s dream. Despite China and Russia blaming Israel for the war and demanding a diplomatic solution, the US strikes three nuclear sites in Iran (21 June) on the 3rd day of his two-week deadline;
How Iran responds remains to be seen, but this action goes against the expectations created by Trump’s two-week deadline;
With the Establishment’s elevation on the global stage, we hope this will allow Pakistan to undertake tough structural reforms and resolve sensitive issues with India (Kashmir and the Indus Water Treaty).
