The International Monetary Fund (IMF) has raised serious concerns regarding Pakistan’s increasing reliance on domestic banks and the State Bank of Pakistan (SBP) for liquidity. The IMF’s latest report, titled “2024 Article IV Consultation and Request for an Extended Arrangement under The Extended Fund Facility,” warns of a “complex tripartite relationship” among the federal government, commercial banks, and the SBP, which it says is contributing to economic instability.
According to the report, the growing financial linkages between Pakistan’s government, the central bank, and commercial banks have created a “sovereign-bank nexus.” This connection poses significant risks, including policy conflicts, regulatory challenges, and an overarching threat to economic stability.
One of the key issues identified is the surge in government debt held by domestic banks, which now accounts for approximately 60 percent of their assets. This level of exposure is more than three times higher than the average seen in other emerging market economies. The IMF notes that this heavy reliance on domestic banks is partly due to Pakistan’s limited access to external funding sources, which has forced the government to increasingly turn to local banks for its financing needs.
In response, commercial banks have primarily met the government’s demand for funds through liquidity support from the SBP, mainly via Open Market Operations (OMOs). This dynamic has made lending to the government more attractive than extending credit to the private sector, leading to what the IMF describes as a “crowding out” effect. Essentially, banks have been incentivized to prioritize government debt over private sector lending, restricting credit availability for businesses and other private entities.
This tripartite relationship has also deeply intertwined the balance sheets of the federal government, commercial banks, and the SBP. As a result, changes or policy shifts in any one of these areas—whether fiscal adjustments, shifts in monetary policy, or changes in the banking sector—can ripple across the broader economy, causing unexpected consequences.
The IMF’s report emphasizes that this dynamic has weakened the transmission of monetary policy in Pakistan. The interconnectedness between policy rates, private credit flows, and investment decisions has become less effective, making it more difficult for the government and central bank to manage economic activity and control inflation.
To mitigate these risks, the IMF suggests that Pakistan needs to take several actions. Addressing fiscal imbalances is a priority, as this would help to reduce the complex interdependencies between the government and the banking sector. Improved cash and debt management could also help, particularly through better utilization of idle public sector cash balances. This would allow the government to balance the investment preferences of banks with its own medium-term strategic objectives.
Furthermore, the IMF urges Pakistani authorities to closely monitor the health of the banking sector and prepare contingency plans in case of economic downturns or financial stress. This would ensure that any shocks to the financial system are managed effectively and that stability is maintained.
In the longer term, the IMF highlights the importance of addressing structural barriers in the financial sector and capital market development. This includes tackling the pervasive informal economy in Pakistan, which continues to pose challenges to financial sector growth and transparency.
The IMF’s warnings come at a critical time as Pakistan faces economic challenges, including high levels of debt, inflation, and the ongoing need for structural reforms. The focus on the government’s relationship with the banking sector reflects broader concerns about the sustainability of current fiscal and monetary policies. As Pakistan navigates its way through these challenges, the IMF’s recommendations could play a crucial role in shaping policy decisions aimed at securing economic stability and fostering long-term growth.