Pakistan declared victory over its economic crisis eighteen months ago. However, that victory is already unravelling, and it will keep unravelling until productivity and small and medium enterprise (SME) credit move to the centre of our economic debate.
In March 2025, inflation fell to 0.7 per cent, the lowest in six decades, per Pakistan Bureau of Statistics (PBS) data. The current account posted its first annual surplus in 14 years, State Bank of Pakistan (SBP) figures showed; reserves climbed, and Fitch, Moody’s, and S&P all upgraded Pakistan’s sovereign outlook, and Islamabad declared success.
By August 2026, PBS data showed inflation back above 11pc, and the State Bank reported the current account back in deficit. The officials who took a victory lap in 2025 are now explaining why the recovery didn’t hold, but they won’t find the answer by asking the questions that produced this outcome the first time.
Every few years Pakistan runs the same script: the exchange rate weakens, inflation spirals, reserves drain, a delegation flies to Washington, austerity follows, the numbers improve, success is declared — and within a year or two, the cycle resets. We just watched it happen in 18 months.
When firms produce more from the same inputs, national income rises; it does not rise because a finance minister negotiated a better loan
Pakistan’s economic debate lives and dies by two numbers: the fiscal deficit and the trade deficit. Both are incomplete, and treating them as the scoreboard is what keeps producing this loop.
How the trade deficit narrows matters more than whether it narrows. A deficit that shrinks because exports grew is progress; one that shrinks because a nervous central bank restricted dollars for importers is contraction dressed up as competitiveness. Two decades and several International Monetary Fund (IMF) programmes later, Pakistan’s export basket is still the same low-value textiles and apparel it was twenty years ago.
The fiscal story looks similar up close. Islamabad narrowed its budget deficit to 2.6pc of GDP in FY26 — the lowest in 22 years — and showed genuine discipline on paper. But discipline achieved by deferring development spending is not discipline achieved by expanding the tax base. The World Bank still projects poverty near 40pc, barely moved by the stabilisation being celebrated in Islamabad.
Behind any economy that doesn’t need rescuing every few years is a simple idea: productivity — how much a firm produces from a given amount of labour, capital and materials. When firms produce more from the same inputs, national income rises — not because a finance minister negotiated a better loan.
Pakistan has three to five million small and medium enterprises, depending on the estimate — itself telling, since much of the sector sits outside formal registration. What isn’t disputed, per Small and Medium Enterprise Development Authority (Smeda) data, is that SMEs make up roughly 90pc of all businesses and employ close to 80pc of the non-agricultural workforce. They are the economy, but the financial system meant to serve them is starving them.
Pakistani banks hold roughly 60pc of their assets in government securities, according to SBP data, against a global average closer to 15pc, among the highest concentrations anywhere. Their investment-to-deposit ratio, per the same data, had already climbed to 94pc by mid-2024, well past the 80–90pc range regulators consider prudent, and every indication since is that it has climbed further.
The consequence for firms is direct. Credit to SMEs has fallen to 6.55pc of total private sector credit, as per central bank data, even though SMEs are 90pc of the businesses seeking it. Private sector credit overall stands at just 11.5pc of GDP in Pakistan, against 35.8pc in Bangladesh and 40pc in India, according to World Bank figures.
This is a rational, if corrosive, equilibrium: treasury bills are profitable and risk-free, while lending to an SME requires credit assessment and tolerance for default. Why bother, when the sovereign offers a guaranteed return? The result is a doom loop — government cannot shrink borrowing without narrowing its deficit, banks cannot reorient toward firms without government stepping back, and the private sector, starved of credit, cannot grow enough to expand the tax base that would let it step back.
A second-order cost is that a banking system earning a safe, guaranteed return has little incentive to mobilise savings. Pakistan’s gross domestic savings rate has fallen to 6.4pc of GDP, from 17.4pc in 1992, a Pakistan Institute of Development Economics study found. Over three decades, Pakistan has saved roughly 11pc of GDP a year against Bangladesh’s 21pc and India’s 28pc. Pakistan also accounts for about 8pc of the world’s unbanked adults despite having under 3pc of its population, per the World Bank’s Global Findex survey.
None of this is a mystery. India’s Jan Dhan Yojana, a state-led push for zero-balance accounts, has enrolled more than 500m accounts since 2014. Reducing Pakistan’s fiscal deficit by expanding the tax base — not deferring development spending — would free bank balance sheets for private lending. The small firm, not the bond auction, needs to become the unit by which we judge whether policy is working.
The right questions are not whether the fiscal deficit narrowed or the current account is in surplus. The right questions are: did credit to small firms increase, did more Pakistanis bring savings into the formal system, did our firms produce higher-value goods than last year.
Pakistan is exceptionally good at stabilisation; it has just proved that twice in two years. It is far worse at building an economy that doesn’t need stabilising at all. That work doesn’t happen in a negotiating room in Washington. It happens in a workshop in Sialkot, where an SME owner can’t get a loan to upgrade her machinery because her bank finds it easier to roll over another treasury bill.
You can stabilise an economy on paper while it hollows out in practice. Pakistan has just shown, in real time, how quickly the paper and the practice come apart.
The writer is an associate professor of economics at IBA Karachi.
Published in Dawn, The Business and Finance Weekly, September 21st, 2026
