The latest monthly economic and development reports issued by the Planning and Finance Divisions present a cautiously encouraging picture of Pakistan’s economy as it enters FY2026-27. Growth improved to 3.7 percent in FY2025-26, large-scale manufacturing returned to expansion, the fiscal deficit narrowed, foreign exchange reserves strengthened and average inflation remained within the government’s target range. After several years of economic adjustment and weak activity, these gains should not be dismissed.

Yet beneath the improved headline numbers lies a familiar vulnerability. As the economy begins to recover, imports are rising much faster than exports, foreign investment remains weak and remittances are once again providing the critical cushion for the external account. This is the same structural imbalance that has repeatedly brought Pakistan’s previous recovery cycles to an early end.

Goods exports declined by 4.6 percent during FY2025-26, while goods imports increased by 9 percent. Including services, exports were virtually stagnant at $40.9 billion, whereas imports rose 8.5 percent to $76.4 billion. The trade deficit consequently widened by nearly $6 billion. The current account, which had recorded a surplus of $1.84 billion a year earlier, slipped into a deficit of $139 million.

The size of the current account deficit is not particularly alarming. The direction of the underlying numbers is. Pakistan was able to absorb the deterioration largely because workers’ remittances rose 8.6 percent to a record $41.6 billion. This is an important achievement and provides valuable support for foreign exchange reserves, which are now considerably stronger than they were during the worst phase of the recent stabilisation period.

But remittances cannot be mistaken for a structural transformation of the economy. It is difficult to claim that the productive base has fundamentally strengthened when Pakistan’s workers abroad are generating more foreign exchange than the country’s export-oriented industries and productive investment at home. The decline in net foreign direct investment makes the contrast even sharper. FDI fell by almost one-third to $1.6 billion during the year. An economy seeking durable growth should ideally see investment responding alongside demand. Instead, domestic activity is recovering while foreign investment remains subdued and merchandise exports are contracting.

The rise in imports should not, however, automatically be interpreted as evidence of another consumption-led boom. Machinery, raw materials and intermediate goods are essential for restoring industrial capacity and supporting expansion. The revival of large-scale manufacturing suggests that at least some of the increase in imports is connected with productive activity.

The concern is what happens next. If higher imports are financing greater productive capacity, exports should eventually respond. If investment is expanding, the economy should develop the capacity to produce more competitively. If neither occurs with sufficient speed, the familiar pattern will re-emerge: domestic demand recovers, imports accelerate, the external deficit widens and policymakers are eventually forced to tighten economic conditions to prevent another balance-of-payments crisis.

This is Pakistan’s longstanding growth dilemma. Demand can recover relatively quickly once financial conditions stabilise, but export capacity, productivity and investment take much longer to develop. Stronger foreign exchange reserves provide a larger cushion and can delay the point at which external pressures become binding. They cannot, however, change the underlying arithmetic. There is one particularly promising area: services exports. Information technology and other business services recorded strong growth, with IT exports reaching $4.6 billion. This is an encouraging development and should be viewed as the foundation of a potentially much larger export sector.

But services cannot yet compensate for weakness in merchandise exports. Expanding them further will require reliable electricity, better digital infrastructure, skilled workers, predictable taxation, improved connectivity and regulatory stability. Without such improvements, the same structural constraints that have limited manufacturing exports could eventually restrict the expansion of services.

The domestic inflation picture provides another reason for caution. Headline inflation fell from 11.1 percent in June to 9.2 percent in July, but consumer prices increased by 1.2 percent during the month after declining in June. Food prices rose 4.16 percent, while perishable food prices surged 17.69 percent. The Sensitive Price Indicator increased 2.4 percent during the month and remained 12 percent higher than a year earlier.

For an economy in which a large proportion of household income goes towards basic necessities, the composition of inflation matters as much as the headline rate. Food alone contributed 1.45 percentage points to the monthly increase. Declines in transport and housing-related costs helped keep overall inflation to 1.2 percent, but that provides little comfort to families facing sharply higher food prices. The rural picture is particularly concerning. Rural inflation remained above the urban rate, while rural food prices increased 3.86 percent during July. A lower year-on-year CPI therefore does not necessarily translate into relief for households whose budgets are dominated by food and other essentials.

Agriculture is also facing constraints that monetary policy cannot solve. The Finance Division reported a 37.3 percent decline in DAP fertiliser offtake during the Kharif season, partly because of high prices. Below-normal rainfall and elevated water stress are adding to the difficulties facing major crops. These problems are compounded by inadequate storage, inefficient logistics, fragmented agricultural markets and persistently low productivity. Interest rates can influence demand and inflation expectations, but they cannot manufacture fertiliser, improve irrigation, conserve water, increase crop yields or eliminate post-harvest losses.

The development spending strategy deserves similar scrutiny. More than 97 percent of the federal Public Sector Development Programme for FY2026-27 has reportedly been allocated to ongoing projects, with more than 60 percent of resources directed towards infrastructure. Prioritising the completion of existing schemes over launching new, thinly funded projects is sensible. Pakistan’s development programme has suffered for years from politically motivated additions, delays and cost overruns.

However, the largely pre-committed nature of the programme also limits the government’s ability to redirect resources towards the supply-side weaknesses now becoming increasingly visible—particularly in agriculture, logistics, technology, exports and human capital. Fiscal consolidation has also produced a mixed picture. The fiscal deficit declined to 1.6 percent of GDP during July-May from 3.8 percent in the corresponding period a year earlier, helped by stronger revenues and lower mark-up payments. But development spending also fell by 8.9 percent.

A lower deficit is clearly desirable, but lower expenditure is not necessarily equivalent to better expenditure. If fiscal consolidation is achieved partly by reducing productive public investment, it may strengthen the immediate balance sheet without improving the economy’s long-term capacity. The government has set a 4 percent growth target for FY2026-27. This is neither an implausibly ambitious objective nor a particularly high one after years of weak growth and disappointing per-capita performance. The real issue is not whether Pakistan can reach 4 percent growth, but what kind of growth will produce that number.

If expansion is driven primarily by domestic demand and import-intensive activity, without corresponding gains in exports, investment and agricultural productivity, the country could simply be bringing the next external constraint closer. Pakistan enters FY2026-27 with better buffers, stronger reserves and greater policy space than it had during the most difficult phase of the stabilisation cycle. That is an important achievement. But the latest official reports provide limited evidence that the underlying structure of the economy has changed fundamentally.

The real test of the new fiscal year will therefore not be whether growth reaches 4 percent. It will be whether exports begin rising alongside imports, whether private and foreign investment respond to stronger demand, and whether agricultural supply improves enough to keep food inflation under control. If those changes do not occur, Pakistan will have achieved another recovery on the same old foundations. The immediate crisis may have been postponed, but the structural weaknesses that repeatedly bring recoveries to an end will remain waiting in the background.