Pakistan's best chance to save its economy

Aasim M Husain

As the military confrontation between Pakistan and India continues to rumble, Pakistan’s economy could be caught in the crossfire. Two weeks after a terrorist attack in the Indian-administered part of Kashmir, India launched a series of strikes on Pakistani territory. The ongoing crisis has fueled concerns that India may try to halt the flow of the Indus River into Pakistan — a threat that Pakistan’s struggling economy can ill afford.

Five decades ago, Pakistan had the strongest economy in South Asia, outperforming India, Bangladesh, and even Sri Lanka in terms of per capita income. Today, the opposite is the case: Pakistan’s per capita income is half that of its neighbours, and it trails them in education, health care, and most other development indicators. While macroeconomic mismanagement has contributed to this decline, an often overlooked — but equally significant — factor is rapid population growth.

When population growth outpaces income growth, per capita income falls. The long-term consequences are far-reaching: a larger population — especially one with a high dependency ratio — means lower household savings, less investment, and slower economic growth. Pakistan’s population has more than quadrupled over the past half-century, and 36% of its residents today are under 15 — far higher than the 22-25% share in Bangladesh, India, and Sri Lanka, where population growth has slowed dramatically in recent decades. As a result, the share of working-age Pakistanis remains below 60%, compared to just over two-thirds in the rest of South Asia.

This demographic imbalance places immense strain on household savings. When earners are outnumbered by dependents, a society’s capacity to save diminishes. That helps explain why Pakistan’s domestic savings rate, at under 7%, is about 20 percentage points lower than in neighbouring economies.

Southeast Asia’s demographic transition during the 1970s and 1980s suggests that, with a working-age population share comparable to other South Asian countries, Pakistan’s savings rate could have been ten percentage points higher. That would have enabled far greater investment in infrastructure, education, and industrial development, boosting GDP growth by 1-1.5 percentage points annually. Sustained over 25 years, these gains could have raised income levels by 30-45% — enough to close the gap with India and Bangladesh.

Pakistan’s investment rate has hovered around 15% — well below other South Asian economies — for decades. Although foreign aid and foreign investment have provided some support, they have done little to address the shortfall in domestic savings and capital formation. The result is a stagnant economy, prone to recurring crises whenever external financing dries up.

The country’s fiscal imbalances have compounded the problem. Today, nearly two-thirds of government revenue goes toward interest payments on debt, leaving little room for public investment or social spending. Efforts to finance deficits through domestic borrowing have crowded out private investment, further weakening growth.

Pakistan now finds itself at a crossroads. The current International Monetary Fund-supported stabilisation programme — up for Board review this week — has brought some macroeconomic relief after inflation surged to nearly 40% in 2023 and foreign-exchange reserves fell to a level that could barely cover three weeks of imports. Debt rollovers by official creditors and falling oil prices have also provided a temporary respite.

But the social and political sustainability of the IMF’s prescribed austerity measures remains in serious doubt. Tax hikes have been fast-tracked, while social spending and investment have been severely constrained. Without new concessional financing, there is no fiscal space for meaningful economic transformation.

A more effective strategy would balance fiscal discipline with long-term development, focusing on three key areas. First, Pakistan must take steps to slow population growth. Expanding access to education — especially for girls — would enable women to enter the workforce, while improved family-planning services could help lower fertility rates.

Bangladesh offers a useful model: its population growth has slowed markedly as female education and employment have increased. Targeted microfinance loans for women have also played a major role. If Pakistan can follow its neighbours’ lead and increase the share of its working-age population by just five percentage points over the next decade, its savings rate would rise substantially, unlocking investment and long-term economic potential.

Second, the country must reform its tax system and improve compliance. Broadening the tax base — particularly in under-taxed sectors like retail and agriculture — and strengthening tax collection could generate an additional 6% of GDP over the next six years. At least half of that revenue should be allocated to social spending and public investment. This is vital not only for sustaining economic growth but also for maintaining public support for structural reforms.

Lastly, greater support from the international community is crucial. Coordinated concessional financing from multilateral and bilateral creditors could help bridge critical funding gaps. These funds should be earmarked for high-impact investments in education, health care, workforce development, and climate-resilient infrastructure.

A demographic shift won’t happen overnight, but the groundwork can be laid now. With the right combination of policies and international support, Pakistan can close the savings gap with its neighbours and facilitate the investments needed to revitalise its ailing economy.

Aasim M Husain is a former deputy director of the Middle East and Central Asia Department at the International Monetary Fund