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Financing private sector-led growth in Pakistan

Credit to the SME sector represented only around 6.3% of total private sector financing in June 2021, meeting the financing needs of only 172,893 SMEs, slightly less than a decade ago. At less than 1% of GDP, SME financing also pales in comparison to Pakistan’s peers. Similarly, while agriculture finance has grown remarkably in recent years and reached a milestone of PKR 1 trillion in disbursements in 2019, it currently meets the needs of less than 25% of farming households in the world. country according to the 2010 Pakistan Agriculture Census. Agricultural finance outstanding also accounts for only 5.6% of private sector finance, an insignificant amount for a sector that accounts for almost 20% of GDP and more than 40% of jobs in the country.

What prevents the financial sector from financing the private sector in Pakistan?

There isn’t just one reason. The status quo is the result of a complex interplay of factors from both the supply or financial sector side and the demand side, which includes individuals, households and businesses that borrow from the financial sector.

The main obstacle on the supply side is government borrowing. Banking sector credit to government jumped 442% in FY11-21, crowding out credit to the private sector. The rapid expansion of government financing led to government credit accounting for 66.8% of all credit granted by the banking sector in December 2021. On the demand side, a large informal sector has was a major obstacle. A large informal sector means that most households, individuals and businesses in Pakistan lack the documentation they need to access the financial sector. These economic agents rely instead on internal financing or informal financing which is generally granted at exorbitant interest rates.

Structural impediments to improving the flow of finance to the private sector require concerted efforts by government, regulators and stakeholders to be resolved. Solutions to many of these challenges are complex and require a whole system approach. Reducing the government’s reliance on borrowing from the financial sector to free up resources for the private sector, for example, requires reducing the budget deficit. This in turn requires greater resource mobilization and spending consolidation measures. Similarly, greater formalization requires, among other things, a reduction in the regulatory burden and upgrading of business capabilities. However, solutions to structural barriers can only be implemented in the medium to long term.

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