Power may flow from the barrel of a gun, as Chairman Mao famously quipped. But the gun and barrel must first be built, then bought, maintained, upgraded – not to mention gunmen trained, fed, clothed, paid and pensioned. National security, in other words, flows from economic strength.
Economic strength (growth) is the product of productive capital and productive labour. On both measures, Pakistan nears the bottom in Asia. According to the World Bank, in 2024, Pakistanis invested 13.1 per cent of their GDP in the economy, a little above depreciation and far below half the South Asian average of 32.2 per cent. Similarly, exclude Afghanistan and Pakistan is at the bottom in South Asia in labour productivity. Its average labourer is not much more than half as productive as its average fellow South Asian.
We focus on the capital problem. First, the 2024 investment figures are no aberration, but a trend entrenched and self-fulfilling. The less you invest, the less you grow; the less you earn, the less you re-invest.
Second, capital invested needs capital saved. It is a country’s domestic savings that generate the bulk of its investment. Pakistan’s domestic savings as a percentage of GDP is 6.4 per cent. Bangladesh is 24 per cent and India 28.6 per cent. Again, no trend fugitive but a pattern embossed.
To attract foreign direct investment, the hurdle is far higher. The challenge for foreign investors in identifying and assessing opportunities, managing macroeconomic and operational risks, and ultimately realising and repatriating profits is orders of magnitude greater than it is for local capital. Foreign investors can choose from opportunities across the globe. When domestic capital is either in flight or sitting idle, pursuing foreign investment beyond a few sovereign-backed or narrowly defined thematic opportunities risks becoming a fool’s errand.
Third, investment to sustain must be profitable – generate a return on capital above its cost of capital. Generally, this is best achieved by financing private investment with its own capital at risk. In 2024, Pakistan’s financial system extended financing worth 11.4 per cent of GDP to its private sector. Compare this to 35.8 per cent of its larger GDP in Bangladesh and 40.0 per cent of its significantly larger GDP in India.
In summary, Pakistan’s financial system lacks the ‘ability’ (the capital base, and given its large undocumented economy, viable credit models) to finance meaningful private capital investment. As we shall soon see, financiers lack even the ‘willingness’ (incentive) to finance private investment.
The ‘what and how’ of deepening and rewiring the financial system to drive investment are known. The problem lies in the ‘who’; such reforms devour capital of another kind: political capital – and lots of it. That, along with the clarity, conviction, steel and endurance of a Lee Kuan Yew. Neither of which our political system generates in abundance.
Let’s drill deeper into the plumbing of the financial system to see where it is clogged to determine the scope of the structural project to fix. That will bring us to the harder question of what is possible in the short term to generate long-term investment.
A financial system runs on three pistons: banks, public capital markets and private capital markets. Banks are its backbone, serving several unique and key functions. For one, banks create about 80 per cent of what we call ‘money’ globally through their fractional-reserve charters. Second, they provide a relatively safe place to save capital, given federal deposit insurance. Then, banks enable governments, businesses and households to reliably make and settle payments. And, finally, they provide all three with financing.
Banks funded by short-term ‘demand deposits’, however, are not set up to lend long-term. Capital investment, by its very nature, is long-term. It takes time to build and ramp up capacity, and even longer to realise returns. Where macro and operating risks are elevated, the risks of lending long compound.
Long-term investment needs long-term savings. This is aggregated by the capital markets that are funded by institutional and high net worth investors who are able to save for longer durations to earn returns higher than bank deposits. While banks provide relatively shorter-term credit, capital markets provide longer-term credit and, critically, growth capital (equity).
The first problem with Pakistan’s financial system is that it lacks scale and is overly reliant on one piston. Banks dominate Pakistan’s financial sector, controlling around 75 per cent of financial sector assets. With commercial bank assets of around 50 per cent of GDP, Pakistan’s banking system is small relative to even its documented economy. In Bangladesh, by comparison, banks’ assets are 60 per cent, and in India, over 70 per cent of their larger economies.
Pakistan’s capital market is yet smaller. With market capitalisation of domestically listed stocks at 14 per cent of GDP, Pakistan’s public market is underdeveloped. India’s ratio by comparison is 131.2 per cent. Private capital markets in Pakistan are near nonexistent outside a few professional investment houses and family offices. Shallow capital markets mean businesses lack access to patient capital to grow, create jobs and generate wealth, while investors lack channels to invest and grow their wealth and reinvest. With the lowest national savings rate in Asia outside of conflict zones, all this is hardly surprising.
The second problem with the financial system is its lack of incentive to finance private enterprise. With the government financing chronic deficits, it sucks liquidity from an already shallow savings pool. Banks in Pakistan largely finance the federation’s deficit ‘risk-free’ (in that governments can print money to repay) and a narrow base of large corporates with collateral to pledge. In 2025, according to the Pakistan Banking Association, the government financed almost 100 per cent of its deficit directly from the banking sector. This crowds out private sector access to finance, existentially so for small and medium enterprises.
The figures here are frightening. In 2025, Pakistan’s financial system extended credit worth 11.5 per cent of GDP to its private sector, compared to 35.8 per cent in Bangladesh and 40 per cent in India. This in itself is a death sentence for economic growth.
In short, without fixing public finances, one cannot generate sustained investment. And one can’t blame the evil bankers this time. We are all, in large measure, creatures of incentive.
The third challenge is market structure, in which five banks, four of which are private, control the majority of banking assets and dominate the primary dealer network that prices government securities auctions. Simply put, four private banks strongly influence the rate the government pays on domestic borrowing. Because loans to private enterprise and households are priced at a premium to government rates, this raises the cost of capital for everyone. It also limits the government’s ability to direct capital to priority sectors (critical to the Asian economic miracle).
Solutions to structural problems are technically complex, politically costly and take many moons to harvest. For instance, fixing public finances requires raising revenue without stifling enterprise, shedding fat in the right places, privatising and/or restructuring loss-making state enterprises, reprofiling public debt and increasing exports to build reserves as essential shock absorbers to anchor the currency against volatility.
Deepening capital markets requires yet another constellation of reforms. For example, switching to a funded, ‘save as you go’ pension system that generates saving pools that need to be invested to meet future pension obligations. The current ‘pay as you go system’ is funded annually via the budget, which generates no such pools and, conversely, incurs a contingent liability that adds to national debt. Similarly, extending insurance penetration generates premium pools today that must be invested in matching long-dated securities to settle future claims. Both are essential for building deep and liquid capital markets.
Pakistan is a country of over 230 million people that will double in around 30 years, at which point it will be the fifth, if not the third, largest country on earth in a geopolitically sensitive neighbourhood. With approximately 45 per cent of its citizens living below the World Bank poverty line, failure to invest in growth and jobs is perhaps best left unimagined.
Or is there an actionable option today to generate investment to unlock growth, productivity, jobs, dignity and a future large enough for Pakistan? Yes, there is.
To be continued
The writer has over 25 years of experience in international development, private equity and development finance. He holds an MBA from Harvard Business School.
