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| Pakistan’s debt debate often focuses on the IMF, but the larger domestic story sits inside the banking system, where government borrowing competes with private-sector credit. |
I have spent enough years around banking to know that risk never looks the same from both sides of a desk.
A businessman walks into a Pakistani bank asking for money to expand a factory. He may need new machinery. Perhaps cash is tight because customers pay slowly while electricity bills arrive on time. The bank studies his accounts and collateral, then asks the question that matters most: will this business generate enough money when the loan falls due?
Another borrower enters the same financial system under very different conditions.
The Government of Pakistan.
It can issue Treasury bills and Pakistan Investment Bonds on a scale no private company can match. Banks understand these instruments. A market already exists for them, and the credit calculation looks very different from financing an exporter whose fortunes depend on orders arriving from Karachi, Faisalabad or Europe.
The latest State Bank of Pakistan debt numbers made me look at that contrast again.
Pakistan's central-government debt stood at about Rs 83.38 trillion at the end of July 2026. The figure was slightly lower than June, so July itself was not another monthly debt surge.
The twelve-month movement tells the more important story.
Central-government debt stood at about Rs 78.24 trillion in July 2025. Over the following year, the stock increased by roughly Rs 5.15 trillion.
Most of that increase came from inside Pakistan.
The Rs 4.3 Trillion Number Pakistan Should Be Discussing
Domestic central-government debt increased from about Rs 54.99 trillion in July 2025 to Rs 59.27 trillion in July 2026.
That is an increase of roughly Rs 4.29 trillion.
External central-government debt also increased, from approximately Rs 23.25 trillion to Rs 24.11 trillion. The increase was much smaller, close to Rs 859 billion.
About 83 percent of the year-on-year increase in central-government debt therefore came from domestic debt.
That number changes the argument.
Pakistanis usually discuss debt through the IMF. Every review becomes breaking news. Negotiations over taxes become political drama, while foreign-exchange targets dominate television discussions.
The July numbers point toward another question.
What happens when the state itself becomes one of the largest borrowers inside the domestic financial system?
Pakistan's debt problem is no longer only about whom the country owes abroad.
It is also about what happens when government financing becomes deeply embedded in the balance sheets of Pakistani banks.
Follow the Banks, Not Just the Debt Headline
SBP monetary data show how large that relationship has become.
By June 2026, net credit to Pakistan's government sector stood at roughly Rs 36.24 trillion. Scheduled banks accounted for about Rs 32.45 trillion.
Private-sector credit stood near Rs 9.92 trillion.
The comparison needs care. Net credit to government is a monetary concept, not simply a count of government securities sitting inside bank portfolios. Government paper also performs legitimate liquidity and collateral functions.
Still, the scale matters.
Scheduled-bank net credit to the government sector was more than three times the stock of private-sector credit in the same monetary framework.
For a banker, the incentive problem is easy to recognise.
A private company requires appraisal. Its cash flow can weaken quickly. Export demand can vanish, while management may make a costly mistake.
Recovering a failed corporate loan can consume years.
Government paper presents a different calculation.
No conspiracy is required. No bank manager needs to make a foolish decision.
Government borrowing can simply become the easier risk-adjusted destination for money.
Karachi Makes the Problem Easier to See
In Karachi, I do not have to imagine what private credit is supposed to finance.
Drive past SITE or Korangi and the need becomes visible. Some factories still work with old machinery. Energy costs squeeze margins, while exporters compete against companies operating with cheaper finance elsewhere.
A manufacturer who wants to modernise production needs a bank willing to understand the business.
That takes work.
The bank has to study the borrower and understand the cash flow. Sector knowledge develops through that process.
Government securities require a different kind of effort.
This does not mean Pakistani banks have stopped financing business.
They have not.
Private-sector credit stood near Rs 9.92 trillion in June 2026, compared with approximately Rs 8.77 trillion a year earlier. The increase matters because it prevents an easy but false conclusion.
Government borrowing has not eliminated private credit.
The more interesting question concerns scale.
When the sovereign offers banks a huge and familiar destination for funds, how aggressively will lenders search for smaller commercial borrowers?
How much time will a bank spend understanding a manufacturer who wants to replace one production line?
Those questions matter because lending to business develops financial expertise that buying another government security does not require in the same way.
Over time, a banking system tilted heavily toward sovereign financing can weaken private investment and economic growth. The IMF has repeatedly identified this risk in Pakistan.
The IMF Has Already Named the Problem
Economists call this relationship the sovereign-bank nexus.
In a 2024 study devoted specifically to Pakistan, the IMF found that Pakistani banks' holdings of domestic government debt had risen to around 60 percent of their assets by 2023.
The same study described Pakistan's banking sector as holding the world's largest proportion of government securities relative to total bank assets at the time of the comparison.
That finding needs to be dated carefully. It describes the IMF's analysis using the data available for that study, not a fresh global ranking for September 2026.
But the institutional message remains powerful.
Pakistan had already developed an unusually deep relationship between government borrowing and commercial-bank balance sheets.
The IMF also found that government credit had become more attractive than private lending and linked the structure to significant crowding out of private credit.
More recent research suggests that the issue has not disappeared.
An IMF working paper published in June 2026 compared sovereign-bank relationships across emerging and developing economies using data through end-2024. Pakistan appeared among the countries where the ratio of bank claims on the public sector to claims on the private sector was particularly pronounced.
The paper used that ratio as a proxy for crowding-out pressure.
That matters because the argument no longer rests on one old snapshot.
Pakistan remains an international outlier in how heavily banking-sector resources lean toward the public sector.
One Reform Changed Who Finances the Government
Pakistan's financing structure also changed because of an important legal reform.
Before 2019, the federal government relied heavily on direct financing from the State Bank of Pakistan.
The arrangement changed first through policy commitments and then through law.
The 2022 amendments to the State Bank of Pakistan Act prohibited direct SBP lending to the government. They also barred the central bank from purchasing government-issued securities in the primary market.
The fiscal borrowing requirement did not disappear.
Commercial banks became even more important in financing it. The IMF describes this shift directly in its analysis of Pakistan's sovereign-bank relationship.
That is an important distinction.
Stopping direct central-bank financing strengthened monetary-policy independence.
But legislation could not remove the government's need for money.
Borrowing moved through a different channel.
Private Credit Has Not Disappeared
The argument needs restraint here.
A commercial bank will not automatically reject a strong corporate borrower because Treasury bills exist.
Private demand for loans also changes with interest rates and economic conditions. During periods of weak investment, businesses themselves may become reluctant to borrow.
The sovereign-bank nexus therefore cannot explain every weakness in Pakistan's private investment.
But incentives still matter.
Government securities help banks satisfy regulatory requirements. They can be traded in secondary markets and used as collateral in SBP liquidity operations.
The IMF also noted another advantage: banks avoid many of the operational costs involved in assessing private borrowers.
No bank manager needs to make a bad decision for the system to produce a bad result.
If government paper repeatedly offers the easier risk-adjusted choice, individual banks can behave sensibly while private finance remains unusually shallow.
A textile exporter should not become an inconvenience beside a sovereign security.
Pakistan needs banks that understand how productive companies actually earn money.
The Interest Bill Shows the Other Side
The federal budget reveals what happens after years of borrowing.
For FY2026-27, the government budgeted about Rs 8.054 trillion for mark-up payments.
Of that amount, approximately Rs 6.983 trillion relates to domestic debt. Foreign-debt mark-up is budgeted at about Rs 1.071 trillion.
Nearly seven out of every eight rupees budgeted for federal mark-up payments therefore relate to domestic debt.
Again, the domestic side dominates.
The government borrows heavily at home, then devotes enormous fiscal resources to servicing those liabilities.
Large financing needs push Islamabad back into the debt market. The interest bill then absorbs revenue that might otherwise support other public spending.
If revenue does not keep pace, the next borrowing requirement becomes harder to escape.
Today's interest bill comes from earlier borrowing, but it also narrows the choices available in the next budget.
The Banks Are Not the Villains
Blaming banks would miss the structure.
Banks answer to shareholders and operate under capital rules. Their managers are expected to control losses.
A bad corporate loan can damage earnings and tie up management attention for years.
Government securities sit differently on the balance sheet.
The IMF noted that Pakistani banks benefited from zero risk weights on government securities under the regulatory framework examined in its 2024 study. Sovereign bonds could also be used as collateral in SBP liquidity operations.
Banks therefore respond to incentives built into the financial system.
Pakistan cannot solve the problem by forcing lenders to make reckless commercial loans.
Bad private credit can destroy a banking system surprisingly fast.
The deeper task is fiscal.
Government financing needs have to become less dominant, while banks need stronger commercial reasons to spend time understanding productive borrowers.
Otherwise, speeches about SME lending will keep colliding with balance-sheet arithmetic.
Pakistan Already Has a Debt Law
Pakistan does not lack legislation.
The Fiscal Responsibility and Debt Limitation Act, 2005, amended again in 2022, provides the federal framework for debt management and fiscal reporting.
The problem is that statutory rules cannot create fiscal discipline by themselves.
A debt ceiling cannot collect taxes.
Nor can a legal target eliminate a persistent financing gap.
If government expenditure and revenue continue to produce large borrowing requirements, the state will return to financial markets regardless of what the legislation hoped to achieve.
The real test is therefore not whether Pakistan has debt rules.
It is whether fiscal policy reduces the borrowing pressure those rules were meant to control.
The Real Competition Happens Inside the Balance Sheet
Pakistan's debt debate usually looks outward.
Attention turns to IMF missions and foreign creditors.
The July 2026 numbers tell us to look inward as well.
Central-government debt increased by about Rs 5.15 trillion over twelve months. Roughly Rs 4.29 trillion of that increase came from domestic debt.
Meanwhile, SBP data show how large government financing already is inside the banking system.
The issue is not that government borrowing is inherently wrong.
Every modern state issues debt.
The problem begins when the sovereign becomes such a dominant customer that financing the state can look more attractive than searching for productive private borrowers.
Pakistan can announce another industrial policy, and ministers can urge banks to support SMEs.
None of that changes the calculation inside a treasury desk or credit committee.
Somewhere inside the banking system, a simple choice still has to be made.
Finance a businessman and accept commercial risk.
Or finance the government.
The uncomfortable question is not why a Pakistani bank sometimes chooses the second option.
It is why Pakistan's fiscal system keeps making that choice so attractive.
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