EDITORIAL: A series of recent policy decisions highlights a renewed push by the Pakistani government to expand financing options and business support for the SME sector.
The proposed reorganisation of the Small and Medium Enterprises Development Authority (SMEDA), the SBP’s launch of a digital financing portal and plans to expand export credit support all point to a focus on widening access to finance and institutional support for micro, small and medium-sized enterprises (MSMEs).
Nevertheless, the initiation of all these measures still beg the fundamental question: does the government truly understand what has held the sector back in the first place? There is a need for policymakers to recognise that these initiatives will achieve little unless the deeper economic and regulatory constraints that have stifled the sector for decades are addressed.
The first problem is a failure to grasp the scale and implications of informality in the MSME sector. MSMEs account for around 99 percent of Pakistan’s businesses and 78 percent of employment, while the economic census indicates that 95 percent of businesses are micro enterprises employing fewer than 10 people. These businesses sustain millions of livelihoods, yet many remain outside the formal economy, effectively shutting themselves out of formal banking finance.
Without documented accounts and verifiable financial records, small enterprises struggle to meet banks’ lending requirements.
Yet the policy debate remains focused on improving access to finance while overlooking the more basic question: why do so many businesses remain informal in the first place?
For many enterprises, informality is not simply a matter of unwillingness to register, but also a response to a business and economic climate in which formalisation costs more than its perceived benefits.
High inflation, exorbitant energy tariffs, expensive inputs and weak purchasing power already leave businesses struggling to maintain viable margins.
Formalisation brings additional tax obligations, labour regulations, social security contributions and administrative requirements. Policymakers cannot reasonably expect businesses to formalise while overlooking the conditions that make the decision financially difficult.
Consider the regulatory burden associated with a business employing more than 10 workers. Labour laws, social security requirements and Employees’ Old-Age Benefits Institution obligations can impose significant compliance costs on small businesses with limited administrative capacity.
Thresholds that trigger additional obligations create a perverse incentive, where instead of hiring more workers and expanding operations, enterprises may choose to remain small or keep employment off the books. There is, therefore, a clear need to examine whether the regulatory framework penalises businesses for expanding operations.
The convoluted withholding tax regime reflects a similar policy failure. Multiple tax rates and withholding obligations at different stages of business transactions raise compliance costs and tie up working capital, disproportionately burdening smaller enterprises. This regime is partly a consequence of the country’s precarious fiscal position.
Faced with chronic revenue shortfalls and a narrow tax base, the FBR has relied on withholding taxes as an easier means of collecting revenue, but at the expense of a business-friendly tax environment. This approach has penalised documented economic activity while doing little to bring businesses operating informally into the tax net.
The government cannot simultaneously lament widespread informality and maintain a tax architecture that makes operating within the formal economy more cumbersome and expensive.
This is the contradiction at the heart of Pakistan’s MSME policy. Policymakers want businesses to formalise, access bank financing, create jobs and contribute to tax revenues. Yet they have failed to address the broader repressive business environment, shaped by an unfavourable macroeconomic climate, high production costs and an onerous regulatory burden that discourages formalisation.
SMEDA’s reorganisation as well as the other measures announced must be accompanied by a serious review of the laws, taxes and economic policies governing small businesses. Otherwise, institutional reform will leave the underlying barriers untouched.
Copyright Business Recorder, 2026