Key Takeaways
- Only 5.5% of bank credit to manufacturing reaches SME borrowers.
- Trade and services receive more than eight times the credit compared to manufacturing.
- Manufacturing sector's share in SME loan book has fallen by 15.6 points over five years.
Pakistan’s economic landscape is dominated by small and medium enterprises (SMEs), with 7.14 million business establishments, according to the Economic Census. However, despite this vast number, only a small percentage of these firms are engaged in manufacturing, accounting for just 9.8% of all SMEs. The majority of SMEs operate within wholesale and retail trade, which constitutes nearly half (45.1%) of the sector’s share.
The government's approach to financing SMEs has been criticized for focusing on consumption rather than production. Over two decades, policies aimed at supporting SME growth have primarily focused on increasing headcount and GDP contribution without ensuring that these firms are adequately financed for productive activities. This focus on consumption has led to a significant misalignment in the allocation of financial resources.
Trade and services sectors continue to dominate credit allocation. According to lending data over the past decade, only 5.5% of all bank credit extended to the manufacturing sector reached SME borrowers. In contrast, trade saw an increase from 33.4% to 40.6%, with banks now more than eight times as likely to lend to small firms in this sector compared to those in manufacturing.
The decline in manufacturing’s share within the SME loan book is stark. From a peak of 46% in 2021, it has fallen consistently, closing at 30.4% by May 2026. This trend reflects a broader shift away from manufacturing towards trade and services, despite the latter not being key drivers of export earnings or productivity growth.
The manufacturing base in Pakistan is characterized by its large number of small firms. Approximately 95% of manufacturing establishments employ fewer than ten people, as per the Economic Census 2023. This informal sector often operates without formal registration, with a formally registered factory outnumbered 28-to-1 by an informal production shop.
The threshold of ten employees is significant in this context. Beyond this number, firms face increased regulatory and legal requirements that can be costly to comply with. As a result, many firms prefer to split into multiple entities after reaching the sweet spot of ten employees, rather than formalizing their operations. This preference for informal structures further exacerbates the issue of inadequate financing for productive activities.
The lending data underscores this trend. A firm that cannot borrow against its own production has limited options for growth and development. The current design of SME policies does not distinguish between a rupee of credit reaching an exporter’s supplier and one reaching a neighbourhood retailer, leading to a misallocation of resources towards consumption rather than production.
