In today’s Finshots, we tell you what’s keeping investments away from our neighbouring country.

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The Story

Pakistan is a paradox right now—a country seemingly on the mend yet trapped in crisis.

Its inflation has plummeted from a terrifying 38% to just 1.5% in two years. The stock market soared over 84% last year. And foreign investors are even dipping their toes back into buying its short-term debt.

So, things should be looking up. The surprising fact, however, is that Pakistan’s own wealthy elite are barely investing in its future.

Because here’s the thing. Pakistan’s economy is driven by consumption, which makes up almost a whopping 80-85% of its economy. But consumption alone doesn’t build a nation’s future. Investment does. And right now, Pakistan’s investment-to-GDP ratio stands at just 13%. It’s the lowest in 64 years. For perspective, the same ratio for India stands at 33%, Bangladesh’s at 30%, and Vietnam’s at 32%.

So how did Pakistan get here, you ask?

For starters, it’s drowning in a huge pile of debt.

Between now and 2029, Pakistan needs a staggering $146 billion to meet its external financing requirements. And even mind boggling is the fact that more than 60% of the government’s budget is swallowed up by interest payments alone. So that leaves barely anything for infrastructure, industry, or long-term growth.

And this isn’t a new problem. Pakistan has been stuck in a debt spiral for decades. It has knocked on the IMF’s door 25 times for a debt bailout since joining it in 1950. Just this year, it agreed to a $20 billion, decade-long deal with the World Bank. And the problem with these loans is that they don’t come free. They come with many strings attached. And without an investment boom to generate real returns, Pakistan is trapped in a vicious loop of borrowing more just to repay old loans.

Now you might ask – if interest payments eat up 60% of Pakistan’s budget, what happens to the remaining 40% of the funds? Sure, it can be used towards public investments. But since the nation has been in this debt cycle for decades, most of that goes toward covering the current expenditures.

Then there’s the problem of investments in speculative assets.

Take for instance Pakistan’s real estate space. Luxury housing and real estate flipping dominate the investment landscape. And these transactions don’t create jobs, boost productivity, or generate exports. They simply shift money from one investor to another, inflating property prices and fueling an economic bubble that adds little to real growth. And while the economy struggles, the wealthy continue their lavish spending sprees. In just six months up to January 2023, Pakistan shelled out a staggering $1.2 billion on luxury car imports, despite facing a forex crisis. This kind of spending drains foreign reserves without contributing to the economy.

And there’s proof it’s causing damage. It’s visible in Pakistan’s shrinking industrial sector. Without industries, there are no exports. Without exports, trade deficits widen. And when a country imports far more than it sells abroad, it gets trapped in a cycle of economic dependence. And all of this further discourages real investments from ever taking root.

And lastly, we have the issue of taxes. Or rather, the lack of it. You see, Pakistan’s tax-to-GDP ratio has hovered around 8-10% since years, which is one of the lowest in the world. The more the government hikes tax rates, the more businesses go underground. In fact, as taxes on dairy and cigarettes increased, companies didn’t pay more but found ways to operate in the shadows. Smuggled goods now flood the market, undercutting legitimate businesses and draining government revenues. And multinational corporations struggle to compete against these illicit imports. All of this shrinks the formal revenues that could have gone towards investments.

So, can Pakistan escape this investment trap?

Well, if you’ve read this far, you already know that Pakistan isn’t an ordinary economy. It’s a complex puzzle that needs unconventional solutions. And there sure are ways to turn things around, but the real question is whether they can actually work.

One potential fix lies in tapping into Pakistan’s massive pool of informal savings. Most households don’t save in the formal sector given dismal financial inclusion, and a rapidly increasing currency circulation. Instead, they stash their money in real estate, gold or keep it hidden away as cash. But if the government can introduce project-specific infrastructure bonds designed to attract these savings, it could unlock a big chunk of capital. Right now, the government does borrow through bonds, but most of the money flows to banks, making it both costly and inefficient. So, a more direct system where individuals can invest in government-backed projects might prove effective.

Another approach could also be learning from India’s playbook. In 1997, India’s “Dream Budget” encouraged people to declare undisclosed income without harsh penalties. And the result was that it broadened the tax base, encouraged financial transparency, and gave the government more resources. Even the IMF has made broadening the tax base a key condition in its latest bailout review of Pakistan.

But let’s be honest. Tax reforms alone won’t solve Pakistan’s problems. History has shown that previous attempts have failed, and the powerful landowning elite won’t easily accept being taxed. So maybe what Pakistan truly needs isn’t just policy tweaks, but a fundamental shift in mindset.

And there’s precedent for this. Vietnam was in a similar rut in the 1980s, but it turned things around by opening its doors to foreign investments and focusing on exports. It integrated itself into global supply chains, and its economy took off.

So yeah, it could be that Pakistan benefits from similar reforms that also make it easier for businesses to operate within the formal economy.

But at the end of the day, none of these solutions could work in isolation. Because Pakistan’s biggest challenge isn’t just debt, industry, or taxation—it’s a fundamental unwillingness among its elite and the government to prioritize long-term investment over short-term speculation.

Even the IMF, after reviewing a decade of its programs, concluded that Pakistan needed a greater sense of ownership over its reforms. Until that changes, Pakistan will continue stumbling from one crisis to another, reliant on bailouts. And time is running out for Pakistan to get this right.

Until then…

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