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The US National Security Strategy document, released in November, clearly spells out America’s foreign policy priorities. It is a candid and easy-to-read paper that builds on several recurring themes: (1) US foreign policy is no longer geared towards being the global policeman, but will focus on national interests; (2) the US will no longer lecture countries on free speech, free press, democracy, human rights and climate change; (3) the US will no tolerate freeloaders, especially amongst its allies; (4) multinational institutions will no longer play a role in global affairs; and (5) the Trump administration will reindustrialize the American economy and uplift the working middle class.
Within a regional framework, it states the following:
For a strategy document that covers US interests globally, the document is conspicuously silent on its military alliances like NATO and the Quad. This suggests that the Trump administration is not interested in military alliances, as it does not view Russia and China as enemies that must face its military strength. The document also reverses the policy to view India as a counterweight to China.
As Iran struggles to calm public protests, experts have said that the theocratic regime may not survive. If so, we argue that the US may shift its military assets from the GCC to the Western Hemisphere, leaving a vacuum that Pakistan could fill. With growing regional interest in Pakistani military hardware and services, the country is well-positioned in 2026.
Expectations that the EFF may allow for a gradual shift towards a growth phase have been dashed. The IMF’s December 2025 Staff Paper, released last week, reads pretty much the same as the May version. The full-year FBR revenue target remains the same (Rs 14 trn), but the federal primary surplus has been increased by Rs 1 trn. The projected fiscal deficit for FY26 is now 4% of GDP, one of the lowest in recent memory. Direct taxes as a percentage of GDP have increased by almost 50 bps in FY26 compared to FY25, and now stand at 5.53% of GDP. If the direct tax base is not increased this year, the burden on the salaried class and corporates will increase further.
This is disappointing as the lead-in to the approval of the 2nd review had been peppered by statements by senior government officials that the current economic strategy was not supportive of growth and job creation. The much-talked-about tax relief for the salaried class is not on the cards, and the third consecutive year of austerity and low growth will not be easy on the hybrid government.
The government has not commented on the new Staff Paper, except to dismiss the view that the new structural benchmarks are not “new conditions” but a continuation of the progress already made. It has also promised that if there is a revenue shortfall this fiscal year (which seems likely), the burden of the shortfall will fall on agri inputs (pesticides and fertilizer) and household purchases via a higher GST rate. This means food prices may increase, which could threaten the IMF’s average inflation projection of 6.3% in FY26. We argue that if this happens, the window to cut interest rates in 2H-FY26 will close.
We expect some pushback against the ongoing austerity, but the GoP should remain firm in its resolve to see the EFF through. The action plan from the Governance & Corruption Diagnostic (GCD) assessment should be released soon, and we expect it to be fully endorsed by businesses and corporations. These are tough institutional reforms that focus on FBR’s operations, GoP’s regulation & oversight functions, the judicial backlog, asset declaration by senior civil servants, and the quality of top management of key state institutions. If these reforms are implemented sincerely, they may convince businesses and professionals to stay the course; if not, the ongoing economic frustration could jeopardize the EFF.
Against a fiscal deficit target of 5.7% of GDP, GoP delivered 5.4% in FY25. Pakistan’s fiscal deficit has been falling since FY23, and this trend is likely to continue in the ongoing EFF. Looking deeper into this fiscal surprise, we do not see much expenditure restraint, as federal and provincial governments have spent freely – especially the Government of Punjab. With three IMF revenue targets unmet in FY25, a blame game has started between the center and Punjab, which will have to be settled before negotiations with the IMF begin next month.
The real game-changer has been the sharp increase in direct taxes (squeezing the salaried class) and abnormally high SBP profits. We show that sales tax collection has lagged, which follows GoP’s failed efforts to get traders and businessmen into the tax net. In FY25, just SBP profits and revenues from PDL matched the revenue collected via GST.
Analysts are confident that Pakistan’s macro stability and comfortable BoP should ensure that the 2nd EFF review will be smooth sailing. We acknowledge the fiscal improvement, comfortable BoP, and low inflation, but argue that lopsided policies and opportunistic revenues contradict the EFF’s objectives. The government’s capitulation to traders/businessmen is understandable, as this segment makes up the core of PML-N’s support base in Punjab. However, the government had committed to doing just that to the IMF.
Without the one-off SBP profits (Rs 2.6 trn), the fiscal situation in FY25 would have been very different. This one-off can be traced to a fiscal distortion, whereby the government’s credit need was so high that Pakistan’s commercial banks could not fund it. Hence, SBP stepped in to generate liquidity that banks then on-lent to the government. As of July 2025, SBP has injected over Rs 14 trn into the system, when good practice demands that the central bank’s net intervention in the money market should be zero. This proves that fiscal policy still dominates monetary policy.
We believe the IMF will insist that GoP continue to narrow the fiscal deficit and secure other sources of deficit financing. This will reduce bank financing to the government, which should match the reduction in artificial liquidity injected by SBP. This means SBP profits in FY26 could collapse. The lopsided fiscal burden will also have to be fixed this year, which means PML-N will have to take on its political base. President Trump may have a soft spot for Pakistan, but we doubt he will go out of his way to tell the IMF to look the other way as Pakistan’s scheming politicians continue to plunder the country.
Pakistan’s external sector will not be as comfortable as it was in FY25. There are concerns that workers’ remittances could fall this year, while the textile sector will have to deal with a poor cotton crop, enhanced GST on inputs, and the loss of captive power. Even SBP has flagged its concern that if the incentives given to banks to increase inward remittances were to be withdrawn, the record-breaking $ 38.3 bln realized in FY25 will not be sustainable.
SBP’s FX reserves have increased even though the monthly trade deficit has been trending up since December 2024. This is because of the steady stream of remittances and last-minute inflows from official creditors at the end of June. With a stable rupee and low inflation, domestic demand has picked up and is now driving imports. In the past month, SBP has weakened the rupee not just to build FX reserves, but also to signal the need to contain imports. However, Pakistanis have dollarized their savings in the past, so if SBP does not strike the right balance with the rupee, we may see a return to dollarization. This could be facilitated if remittances from Saudi and the UAE start shifting to the hundi/hawala system.
In our view, the austerity of the ongoing EFF is likely to be watered down as the political cost of a stagnant economy increases. We do not expect a policy-driven growth boost in FY26, but some of the restrictions on non-filers could be eased, while industries like textiles, cement, and autos may get relief from the measures announced in the FY26 budget.
This has happened before. Pakistan somehow manages to get lucky, and uses this luck to halt and often reverse much-needed structural reforms: we saw this happening after 9/11; we witnessed the strong growth when oil prices collapsed in mid-2015; then we had the Covid-19 boom; and finally, the global elevation after the 4-day war with India in May. But there is an irony about all this: the lucky breaks are celebrated by insiders, but also keep undermining the creation of a strong foundation for future growth.
The global turmoil is not just about the tariff rates the US had imposed, or their global reach, but the last-minute reprieves and contradictory statements made by Trump. Unless you are an importer in the US, it is hard to know what the current tariff incidence is. Mainstream media has nothing positive to say about this Trump-driven turmoil, but it also doesn’t have the depth to understand how the US, as the issuer of the global reserve currency, suffers from persistent overvaluation of the dollar, and how this has de-industrialized the US economy.
There are competing models of how currencies reach their equilibrium level. The trade model says that countries that run persistent external deficits should witness currency weakness. The financing model focuses on global investments in financial instruments, and claims that currency equilibrium is achieved when global investors are indifferent between dollar and non-dollar investments. The Triffin Dilemma focuses on the reserve currency (the US$), and shows that the trade and financing models don’t work because there is always strong demand for dollars as global trade grows.
Since global trade volumes have increased sharply in the past several decades, the dollar is persistently overvalued, which makes the US manufacturing sector less competitive. The Triffin Dilemma basically says that for the country issuing the global reserve currency, there is a conflict between domestic economic goals and its global obligations.
An overvalued dollar allows the US to keep interest rates low and gorge on cheap imports, but it also makes US manufacturing less competitive. The era of globalization has seen parts of the US reduced to ghost towns with impoverished residents, which explains Trump’s popularity with diehard MAGA supporters.
Stephen Miran, the head of the Council of Economic Advisers, had released a paper in November 2024 where he spelled out Trump’s tariff plan that is currently playing out. His assessment that US manufacturing needs to be rebuilt, and blue-collar jobs need to return, has strong political overtones but also has common sense logic. Using the Triffin Dilemma and simple language, Miran argues that Trump is trying to address the structural bias against US manufacturing by forcing trading partners to share the economic burden of issuing the global reserves and the defense shield the US provides to Europe and Southeast Asia.
However, Miran’s arguments are not water-tight, while Trump’s rambling narrative on tariffs has created utter confusion about what the US is trying to achieve. In simple terms, if Trump wants to create blue-collar jobs and reduce the US trade deficit, he must sharply increase the price of imported goods even if it spikes US inflation and hurts US tech firms. If he wants to impose tariffs and keep domestic prices down, he needs to depreciate the dollar and move away from being the global currency. He cannot do both.
We argue that Trump’s political instinct is to prioritize domestic goals over global obligations. However, his insistence that the dollar remains the global currency and US prices remain low, will not bring back blue-collar jobs to the US. Trump desperately needs a consistent economic roadmap, as his desire to achieve contradictory goals will only serve to isolate the US. With time, the rest of the world will find alternative trade and security arrangements where the US has no role. This means Trump is accelerating the demise of US power.
Trump’s tariff announcement was worse than anticipated. Across the board and not sparing allies, even close ones like Israel and Taiwan. Analysts were quick to point out that the tariffs computed by the White House were flawed, but we think that point is irrelevant. Trump will never acknowledge his mistake and will only double down.
What’s more important is how this tariff war is being perceived by the Trump administration. On paper, it is moderate (only half the alleged tariffs imposed by countries on US exports) and unbiased (friend and foe are seen as one). The world is scrambling to respond, with indications that China will impose counter-measures against the US, while the UK may let this one slide. The EU is talking big, but is unlikely to deliver.
The pain is already being felt. Not the rise in US retail prices, but the job losses in Canada, which are likely to happen in Mexico. For export-led countries, the challenge is existential. Pakistan has been aspiring to be an export-led country for decades, but has never managed to achieve it. Perhaps that is a blessing now. In our view, Trump’s tariffs will not be as disruptive to Pakistan as they will to most other countries. Some local analysts are already looking at the opportunities it could create for our exports of textiles and garments against countries like China and Bangladesh.
While the US will be willing to consider side deals on a bilateral level, US tariffs are here to stay. This means most OECD countries will slip into recession, and global trade flows and investment could become more regional. Trump’s tariff war is really about how developed nations are able to manage the resulting economic pain. The US is better placed than the EU and export-led countries in Southeast Asia. We also predict a shift in power within the Trump administration, as globalists like Elon Musk are eclipsed by nationalists like Steve Bannon.
The pace at which President Trump is challenging the global order,… is dizzying. Over the weekend, his administration has said that returning to Ukraine’s pre-2022 borders is unrealistic, that Europe’s security threats are from within (not from Russia and China), and that Palestinians should be relocated from the Gaza Strip so that the US could take charge of the area. And it’s been less than a month since Trump took charge.
This paper seeks to understand why the US view has changed so radically. We argue that the Trump administration sees the challenges facing Western Europe as similar to the US, and suggests that Europeans should focus on immigration and stop discriminating against right-wing political parties. We also think this transition of Pax Americana, requires changes in how Western European countries view NATO and the threat from Russia.
With the rise of right-wing parties in Europe, Trump thinks there is popular support to dismantle the old system, which could be an existential threat to the European Union. As someone who prefers bilateral deals to collective actions, we argue that Trump would be happy to see the end of the EU and NATO. Shifting away from a rules-based system could result in significant changes in the United Nations – its Charter and perhaps the composition of the permanent members of the Security Council, with India replacing the UK and France.
The world, according to Trump, should focus on how the real powers set their own agenda, which is unhindered by global institutions and international law. As he has already done, the use of tariffs to secure revenues, bring back jobs, and secure concessions from US trade partners, has already made some global institutions irrelevant. In our view, the big boys are the US, China, Russia, and India, who will deal with each other and carve out their spheres of influence.
Pakistan is not well placed to adapt to the new world order. Its democratic foundations have been systematically weakened, and its economy needs the IMF. The composition of the Trump administration and Modi’s state visit to the US, suggests the US may not have a favorable view of Pakistan. While most countries will struggle to position themselves in the new world order, Pakistan is particularly vulnerable. If Pakistan’s power brokers do not accept the need to challenge the entrenched status quo, it could become globally isolated. With weak global institutions, being left behind could be an existential threat.
The conviction of PTI supporters in military courts and the almost immediate mercy granted to some, has raised eyebrows. Against the backdrop of Grenell’s repeated tweets to release IK, people sense that something is happening behind closed doors.
Pakistan may not be high on Trump’s agenda, but the similarities between IK and Trump cannot be denied. For someone who has always complained about being targeted by the deep state – which he has vowed to dismantle, Trump will see IK’s incarceration as a misuse of power by our deep state. The timeline for a deal between the incoming Trump administration and the Establishment is short, as Trump’s inauguration speech is only weeks away.
IK’s possible release and early elections will go together. We argue that the evolution of hybrid arrangements in Pakistan has weakened public support for the Establishment as it gains more executive power. Print media has become vocal about rising authoritarianism in the country and how Pakistan’s Western provinces are being mismanaged. The need for political solutions to Pakistan’s myriad problems is glaringly obvious.
With the backdrop of potentially monumental changes in the world order after Trump takes charge, a reconciliation between the Establishment and IK may not attract much global attention. With EFF reforms on the back burner – lots of talk but no action, Pakistan needs a strong government to implement structural reforms. A political transition in 2025, with the Boys stepping back, may be the right solution for the country.
Trump is moving fast to create his team. The nominations show that Trump intends to deliver on his campaign promises to deport undocumented migrants, downsize the federal government, clean up what he calls the deep state, facilitate the fossil fuel industry, and impose tariffs on China, which now includes Mexico and Canada as well.
This paper seeks to analyze the impact of US tariffs. While the conventional wisdom is that tariffs reduce global welfare via the gains from free trade, one must realize that the Neoliberal order is the exception in US history, not the norm. Tariffs protect domestic industry and blue-collar workers with the larger goal of prioritizing its own citizens. Trump will surely deliver on his promise.
Unilateral tariffs reward the imposing country at the expense of its trade partners. This is well documented as beggar-thy-neighbor policies were often used before WW2. We argue that Trump’s tariff policy is primarily aimed at achieving domestic political goals, and while he will be able to bully Mexico and Canada – which are acutely dependent on the US market for their exports – this will not work with China. Such a move will trigger counter-tariffs against the US, which could unleash trade wars where powerful economies use the threat of tariffs to gain an advantage over trade partners.
Pakistan is not as vulnerable to trade wars as countries like Hong Kong, Singapore, Vietnam, Ireland, the UAE, and Malaysia. The real risk is the escalating nature of trade wars, as aggrieved countries will strike back. With the US taking the lead, global agencies like the IFIs will be unable to punish trade aggressors, which could result in the end of the rule-based global order.
While this may seem a regressive step in global progress, one must realize that the gains from free trade are often concentrated on a small elite. The resulting income inequality has created a growing demand for restricting trade and immigration, which has taken root in the US and Europe. We can only wait and see how this plays out when Trump takes the oath of office on 20 January 2025.
The IMF Staff Paper was released after an unusual delay. Media coverage has been extensive, with a specific focus on the dismantling of agri support prices, the expected mini-budget, winding up special economic zones, and clipping the powers of SIFC. The document supports Pakistan’s economic management and praises the macro stability that has been embedded since mid-2023.
Instead of repeating this discussion, we have focused on the IMF’s 5-year projections of key macro variables. The point is not to hold the IMF to account when the projections are not realized, but to see how the recent projections compare with the IMF’s projections from July 2023. Behind all projections are specific assumptions, and this exercise seeks to gauge how the IMF’s assumptions about Pakistan have changed in the past year. More specifically, we compare the Staff Paper from July 2023 and the one just released, and focus specifically on Pakistan’s fiscal accounts, its BoP flows, and the country’s external financing needs and sources.
The IMF’s perspective has changed with the following insights for the next five years:
From the Staff Paper, we would suggest new certainties: the tax base must be increased; development spending cannot be squeezed; the IMF will not be generous with waivers for failed targets; economic decision-making must be transparent; and Pakistan must deliver on its promises to use digital means to ensure tax compliance. This may sound familiar enough, but we sense some urgency in the IMF’s tone.
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