Zafar Iqbal
Whenever discussions arise regarding Pakistan’s credit-to-GDP ratio, a familiar refrain is often heard: the government is crowding out the private sector. Currently, government borrowing accounts for over 70 percent of the liquidity in the banking sector, effectively consuming most of the available capital. This situation has led many to claim that entrepreneurs and exporters are starved of the financial resources they need to thrive. Terms like “value addition,” “fiscal space,” and “crowding out” have become commonplace in debates, often used without thorough examination or critical thought. They serve as stand-ins for genuine analysis instead of stimulating deeper conversations about the underlying issues.
However, the main issue is not that this theory is inherently erroneous; rather, it has simplified the debate into a one-dimensional idea. The prevailing belief is that if the government would simply borrow less, banks would, in turn, start lending more to the private sector. But this assumption has been put to the test and has failed to hold water. Over the past twenty years, the state has repeatedly attempted to “set liquidity aside” for private enterprises, and the primary approach has been the refinance scheme. This scheme involves the central bank generating liquidity and supplying it to banks at zero or very low rates, aiming to direct credit towards sectors often overlooked by traditional finance, such as small and medium-sized enterprises (SMEs), exporters, housing, and renewable energy projects.
At first glance, these refinance schemes seemed effective. Liquidity surged, interest rate spreads diminished, and targets were achieved. However, they did not change the fundamental dynamics of credit distribution. Banks continued to bear 100 percent of the credit risk, leading them to stick to their usual lending patterns: financing large corporates, familiar clients, and borrowers who could provide collateral. In essence, refinancing effectively reduced the costs for already viable clients without expanding access to credit for those who needed it the most. It did nothing to shift banks’ risk appetites.
This raises an important question: might banks’ reluctance to broaden their lending horizons have more to do with their risk assessments than with the liquidity in the market? Over time, the refinance schemes quietly contributed to monetary expansion. The State Bank of Pakistan (SBP) injected substantial amounts into the economy, inflating the money supply without proper budget oversight and obscuring the actual fiscal costs associated with subsidized lending. These schemes operated as quasi-fiscal measures, framed as developmental finance yet primarily benefiting a select few while contributing to inflationary pressures felt by the broader public.
As Pakistan navigates the ongoing International Monetary Fund (IMF) program, this façade is beginning to crumble. The refinance function is shifting from the SBP to the Ministry of Finance (MoF), which means that subsidies will now be explicitly accounted for within the national budget, likely channeled through developmental finance entities like the EXIM Bank. On paper, this transition enhances transparency: the fiscal costs will become visible and subject to more disciplined budgetary procedures. While the inflationary risks remain, they will now be tied to legitimate fiscal trade-offs rather than hidden off-budget expenditures.
However, it is crucial to note that improved transparency does not automatically lead to better outcomes. The shift from the SBP to the MoF does not change the fundamental behavior of banks. Regardless of whether liquidity is generated by the central bank or subsidized through the government budget, lending decisions still lie with the banks, as does the responsibility for assessing credit risk. Unfortunately, many Pakistani firms struggle in this area—not because they lack business viability but because they often do not have sufficient collateral, audited financial statements, or established relationships with financial institutions.
This highlights the real constraint in the system: it is not liquidity or crowding out that is the issue, but rather risk. The data supports this claim. Pakistan’s private sector credit-to-GDP ratio has remained stagnant below 15 percent for over a decade, even during periods like 2022 when refinance constituted about 20 percent of total private sector lending. In contrast, peer economies in South Asia and other middle-income countries have managed to expand credit penetration without relying on these artificial liquidity measures. The crux of the matter lies in systemic design rather than simply the availability of funding.
Thus, the idea that crowding out is the singular explanation for Pakistan’s stagnating credit landscape is misleading. The more accurate narrative is one that centers on institutional weaknesses: a persistent unwillingness to engage with unfamiliar risks, a regulatory environment that discourages diversification, and a policy discourse that continues to promote liquidity as a solution to a problem deeply rooted in risk management.
Until there is a fundamental shift in these areas, liquidity will continue to circulate among the same established borrowers, leaving the broader economy and potential new entrants excluded from the financial resources they desperately need. Addressing these institutional barriers and rethinking the risk assessment criteria can pave the way for a more inclusive financial environment where entrepreneurs and businesses across sectors can access the capital necessary for growth and innovation. Only then can Pakistan hope to see meaningful improvements in its credit-to-GDP ratio and overall economic health.
