Each time the conversation turns to Pakistan’s credit-to-GDP, a familiar chorus follows: the sovereign is crowding out the private sector. Government borrowing is now over 70 percent of the banking sector liquidity, and is said to be absorbing all available capital, leaving none for entrepreneurs or exporters. Like “value addition” or “fiscal space,” crowding out has become an overused and underexamined refrain - repeated so often it now functions as a placeholder for serious thinking.
The problem is not that the theory is always wrong. The problem is that it has flattened the debate into a single, self-reinforcing belief: that if the state would simply borrow less, banks would resume lending to the private sector.
That assumption has been tested. And it failed. Over the past two decades, the state has repeatedly tried “setting liquidity aside” for the private sector. The instrument of choice was the refinance scheme: liquidity created by the central bank and supplied to banks at zero or heavily concessional rates. These schemes were ostensibly meant to channel credit to sectors that markets overlooked: SMEs, exporters, housing, renewables.
It worked, at least on the surface. Liquidity flowed, spreads narrowed, and targets were met. But none of it changed the basic credit calculus. Because banks still bore hundred percent of the credit risk,they predictably lent to the same credit profiles they always had: large corporates, familiar clients, and borrowers with collateral. Refinance simply made already-bankable clients cheaper to finance. It did not expand access. It did not alter risk appetite.
Is it possible that bank’s aversion to widening the credit net had little to do with access to liquidity, and more to do with their risk assessment? What refinance did achieve, quietly was monetary expansion. SBP injections inflated the money supply, bypassed budget scrutiny, and masked the true fiscal cost of subsidized lending. These schemes functioned as off-book quasi-fiscal operations, sold as developmental finance. The result: cheap credit for a few, inflation for the rest.
Under the conditions of the ongoing IMF program, the façadeis being dismantled. Refinance is being pushed out of SBP and into the finance ministry. Subsidies will now be explicitly budgetedfor, and likely routed through developmental finance institutions such as the EXIM Bank. On paper, this improves transparency. The fiscal cost is now visible and subject to budgetary discipline. The inflationary impulse, while still present, is at least attached to real expenditure trade-offs.
But cleaner optics do not guarantee better outcomes. Nothing about the shift from SBP to MoF alters banks’ core behavior. Whether liquidity is created at the central bank or subsidized through the budget, the lending decision still rests with the bank, as does the credit risk. And most Pakistani firms still fail that test—not because they lack viability, but because they lack collateral, audited accounts, or institutional familiarity.
That is the real constraint. Not liquidity. Not crowding out. Risk.
And the data reflects it. Pakistan’s private sector credit-to-GDP ratio has remained stuck under 15 percent for more than a decade, even during years such as 2022 when share of refinance climbed up to 20 percent of total private sector lending. In contrast, peer economies in South Asia and the broader middle-income cohort have steadily expanded credit penetration, without relying on artificial liquidity windows. The difference is not funding availability. It is system design.
So no, crowding out is not the one-size-fit-all explanation for Pakistan’s credit stagnation. The real story is institutional: a refusal to underwrite unfamiliar risk, a regulatory framework that punishes diversification, and a policy discourse that keeps prescribing liquidity for a problem rooted in risk.
Until that changes, liquidity will continue to rotate around the same borrowers, even as the rest of the economy remains locked out.
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