Government Borrowing Surge Crowds Out Private Credit

Islamabad: Pakistan’s federal government has significantly accelerated its reliance on commercial bank financing during the first seven months of FY26, heightening concerns that persistent sovereign borrowing is constraining private sector credit expansion and suppressing broader economic momentum.

According to figures released by the State Bank of Pakistan (SBP), cumulative government borrowing from banks reached Rs1.912 trillion in 7MFY26, compared with Rs408 billion in the corresponding period last year—reflecting an almost fivefold year-on-year surge.

The borrowing pattern indicates that fiscal stress remains pronounced despite reported gains in revenue mobilization. In FY25, total bank borrowing closed at Rs5.4 trillion, with a substantial portion raised during the latter half of the fiscal year. If the current trajectory persists, aggregate borrowing for FY26 is likely to surpass the previous year’s total, reinforcing the government’s structural dependence on domestic banking liquidity.

The expansion of bank-based deficit financing has become a defining feature of recent fiscal cycles. In FY24 alone, sovereign borrowing reached Rs8.5 trillion, largely to fund escalating current expenditures. Meanwhile, interest payments in FY25 approached Rs8 trillion, cementing debt servicing as the single largest line item in federal expenditure.

Market participants caution that sustained sovereign absorption of banking resources is exerting a crowding-out effect on private enterprise. Although headline inflation has moderated, policy rates remain elevated relative to both inflation and regional benchmarks, dampening appetite for long-term capital formation and industrial expansion.

In an effort to ease liquidity conditions and stimulate private credit growth, the SBP recently reduced the Cash Reserve Requirement (CRR) from 6 percent to 5 percent. While the measure injected incremental liquidity into the banking system, financial sector analysts suggest that excess funds are more likely to be deployed into government securities, given their low-risk profile and comparatively attractive yields. Heightened default risk in corporate lending continues to weigh on banks’ risk-adjusted return considerations.

Corporate borrowing trends underscore prevailing caution: businesses are primarily accessing short-term facilities to finance working capital needs rather than undertaking new capital expenditures. Structural impediments—including elevated energy tariffs, high input costs, a burdensome tax regime, and administrative inefficiencies in tax enforcement—remain critical deterrents to fresh investment.

Investor confidence is further undermined by domestic political volatility and escalating regional geopolitical tensions. Analysts point to risks of broader instability linked to potential military escalation involving Iran, Israel, and US forces, factors that amplify uncertainty in an already fragile macroeconomic environment.

Both domestic and foreign investors remain risk-averse, with some Pakistani enterprises reportedly diversifying or relocating segments of their operations to Central Asia, Africa, and Mexico in pursuit of more stable operating conditions. Economists broadly contend that a meaningful revival in private investment will hinge on sustained macroeconomic stabilization, credible fiscal consolidation, and a reduction in political and security-related risk premiums.