Global ratings agency Fitch has signaled improved prospects for Pakistan’s banking sector, pointing to easing inflation, a more stable currency, and signs of an economic rebound.

Economic Turnaround Underpins Forecast

After years of volatility, Pakistan’s economy is showing signs of recovery. Fitch expects GDP growth to reach 3.5% in FY27, with inflation stabilising near 5%. This marks a sharp shift from May 2023, when consumer inflation had surged to nearly 38%. By July 2025, the rate had cooled to 4.1%, helped by the State Bank’s aggressive policy easing — cutting rates from 22% to 11% since May 2024.

The improvement in fundamentals prompted Fitch to upgrade Pakistan’s sovereign rating to B- / Stable earlier this year, lifting it from a distressed CCC+. The agency cited fiscal reforms and stronger external buffers as critical factors behind the upgrade.

What It Means for Banks

With financing conditions improving, Fitch believes local banks are positioned to benefit from a revival in credit demand. Private-sector lending, currently at just 9.7% of GDP, is expected to expand as businesses regain confidence and borrowing costs fall. This shift could gradually reduce banks’ heavy dependence on government debt, which has long limited their lending role in the wider economy.

Stronger loan demand is also expected to support deposit growth, keeping liquidity healthy. However, Fitch cautioned that the sector’s fortunes remain closely tied to the government’s financial health, given banks’ large holdings of sovereign securities and exposure to state-backed entities.

Asset Quality and Profitability Trends

The sector’s non-performing loan ratio improved to 7.1% by March 2025, down from 7.6% a year earlier, supported by robust loan growth of 26%. Although credit expansion is expected to slow, lower interest rates should continue to strengthen repayment capacity, keeping asset quality stable.

Banks’ profitability, however, has come under pressure. Return on equity fell to 20% in Q1 2025 from 27% in 2023, largely due to narrowing net interest margins and elevated operating costs from inflation. Non-interest income provided some relief, and Fitch expects earnings to remain resilient, driven by loan expansion and treasury gains, even if margins stay under strain.

Capital Strength Provides Buffer

One of the sector’s strongest points remains its capital base. Pakistan’s banks posted a capital adequacy ratio of 21% in March 2025 — the highest in a decade and well above the regulatory minimum of 11.5%. While greater exposure to private-sector credit could reduce this cushion slightly, Fitch still expects banks to maintain a strong capital position.

Bottom Line

Fitch’s analysis suggests Pakistan’s banks are entering a more favorable phase, benefiting from macroeconomic stabilisation and policy reforms. Yet, the report also underscores a persistent vulnerability: the sector’s health remains closely linked to the state’s fiscal trajectory. Sustained reforms, deeper credit penetration, and a durable recovery in private lending will be key to unlocking long-term growth for the industry.