Pakistan's fragile macroeconomic recovery, which began in 2025, is now stalling as inflation rebounds and fiscal pressures mount, according to a new report by the Policy Research Institute of Market Economy (Prime). The think tank warns that geopolitical headwinds have pushed consumer price inflation back into double digits, eroding the monetary freedom of individuals and businesses in an economy where over 80 percent of the labor force operates informally. Main Developments Consumer Price Index (CPI) inflation stood between 10.9 and 11.7 percent from April to June 2026, while the Sensitive Price Index climbed to 12.8 percent by June. On an annual basis, urban inflation surged 11.11 percent against 10.56 percent in rural areas in April. Debt servicing and defense spending consumed 94 percent of net federal revenue in the latest fiscal year, leaving just 6 percent for health, education, infrastructure, social protection, and all other essential government functions. The report noted that defense spending had increased further in recent years. Read also: Pakistan's AI pivot: From record IT exports to global cooperation Credit to the government sector stood at Rs37.2 trillion in May 2026, compared with Rs13.8 trillion for the private sector. This means the government absorbs nearly three times more credit than the entire private sector, severely crowding out private investment. Background Using the Heritage Foundation's Index of Economic Freedom, Prime assigned Pakistan a score of 48.9, placing it in the "Repressed" category. The index evaluates 12 indicators across four pillars: Rule of Law, Government Size, Regulatory Efficiency, and Open Markets. Pakistan scored 25.7 for property rights, 27.6 for judicial effectiveness, 26.3 for government integrity, and 10.1 for fiscal health. However, Prime argued that even seemingly favorable scores, such as 88.5 for Government Spending and 78.2 for Tax Burden, conceal the reality that Pakistan is neither a lean nor a low-tax state. The Labour Force Survey 2025 reported that 80.8 percent of the labor force worked in the informal sector. A salaried individual earning Rs5 million faces an effective tax rate of 33.29 percent, with tax deducted at source, leaving little scope for evasion. By contrast, a shopkeeper earning the same amount pays just 0.5 percent under presumptive and fixed tax schemes. Why It Matters The disparity in tax treatment highlights systemic inequity: the documented economy bears a disproportionately heavy tax burden while the informal sector remains largely untaxed. Prime noted that Rs2.353 trillion in tax expenditures represent preferential treatment for selected sectors, funded through higher rates imposed on documented taxpayers. The Budget 2026-27 offered limited relief to the salaried class and did nothing to bridge the gap between formal and informal sector taxation. Meanwhile, the fiscal deficit is projected to narrow to 3.6 percent of GDP, with a primary surplus of 2 percent, but this improvement is largely attributable to lower interest rates rather than structural reform. Prime described Pakistan's financial freedom score of 60.0 as sharply contradicting ground reality. "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. What's Next The report urged a policy shift from the reactive stabilization required under the IMF program to a resilience-driven framework that ensures economic freedom. Recommendations include lowering tax rates by broadening the effective tax base, reducing the General Sales Tax to 15 percent, cutting the corporate tax rate to 25 percent, 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 15 percent customs duty ceiling, and replacing the Petroleum Development Levy with a uniform GST rate. The report argued that frequent changes to the PDL create uncertainty and reduce transparency for consumers. The National Tariff Policy 2025-30, which reduces customs duties on 3,125 tariff lines, was noted as a positive step for economic freedom. In FY26, customs revenue increased from Rs1.588 trillion to Rs1.651 trillion despite the rate reductions, suggesting the policy may be broadening the tax base.