The growing trade deficit exposes Pakistan’s structural weaknesses

The debate on the economic structure and its implications for the balance of payments crisis has become increasingly widespread as imports begin to rise, subsequently leading to a higher trade deficit.

Policy makers often start to panic as calls are made to limit imports. Several key studies on the subject have pointed to low productivity, the inability to accumulate knowledge and build the necessary human capital, and most importantly, the failure to attract efficiency-driven investment as the main obstacles to economic growth in Pakistan.

It is imperative that any agenda to bring about significant economic reforms and structural transformation begins with an understanding of these key obstacles. Trade statistics for November 2025 reveal an annual increase of around 33% in the trade deficit, with exports falling by 15% and imports increasing by 5%. Total exports in the first five months fell by 6.4%, while imports rose by 13.3%, resulting in a 37.2% increase in the trade deficit.

The widening deficit, as exports plummet while imports continue to rise, has once again turned the focus on a looming balance of payments crisis. It is important to note that the fall in global oil prices, the recent favorable completion of the review of the expanded capital facility by the Executive Committee of the International Monetary Fund (IMF) and the expected increase in remittances as Ramazan and Eid approach are likely to provide some leverage to policy makers on the foreign front.

However, it has become necessary to ensure that the government introduces economic reforms to stimulate economic transformation, rather than resorting to measures that restrict imports and return the economy to a vicious cycle involving a balance of payments crisis followed by steps to suppress growth and import demand. The Economic Advisory Group has published several data stories on how restrictive Pakistan’s trade policy is relative to other countries in the region.

A recent article by Atif Mian highlighted the lack of productive investment in Pakistan, which is hindering the transformation of the economic structure and limiting the capacity to boost production. Pakistan’s gross fixed capital formation as a percentage of GDP, indicating the level of net fixed assets acquired relative to total output, was 11% in 2024, compared to 28% for South Asia and 35% for East Asia and the Pacific.

This places Pakistan among the lowest not only in the region but also globally. Net foreign direct investment inflows in 2024 totaled $2.7 billion, according to the World Bank’s World Development Indicators, compared with $30 billion for South Asian economies and $480 billion for East Asia and the Pacific.

A third of global foreign investment flows to the East Asia and Pacific region, which is rightly characterized as a global manufacturing hub. Integration into regional production networks complements the flow of foreign investment in manufacturing. While the lack of both domestic and foreign investment is worrying and requires a holistic approach to ensure meaningful improvement, a less highlighted but critical issue is the low level of trade openness in Pakistan, which speaks volumes for weak trade integration with comparable regional markets.

An indicator of integration in global and regional supply chains is participation in global value chains (GVCs), where gross exports are broken down into forward and backward linkages. Forward linkages represent exports that are re-exported either to third countries or back to Pakistan after processing at the importing partner, while backward linkages are imports that are processed and re-exported either to the original trading partner or to third countries.

Essentially, GVC-related exports involve multiple border crossings and are highly dependent on strong trade ties between trading partners. High levels of GVC participation not only require products to meet internationally accepted standards and quality, but also to be produced at highly competitive costs to attract consumers and producers in many countries.

According to United Nations ESCAP data on global value chain participation, Pakistan performs poorly in both forward and backward linkages, with less than a quarter of its exports being GVC-related. Over 40% of exports from the Asia-Pacific region and over 45% from Southeast Asian countries are GVC-related.

In these economies, exports in high-value-added sectors such as transport equipment and electrical machinery are driven by backward linkages, where imported inputs are transformed into exportable output. Only about a quarter of Pakistan’s textiles and textile exports are GVC-related, with the majority classified as forward linkages.

In comparison, GVC-related exports account for one-third of Bangladesh’s gross textile exports, with more than two-thirds categorized as backward linkages. Pakistan usually supplies intermediate goods, while Bangladesh imports inputs and processes them into final goods for export. This explains Bangladesh’s stronger focus on value addition in the textile sector.

Therefore, Pakistan needs to introduce policies that encourage participation in global value chains, prioritizing tariff reduction and regional trade agreements with economies that can provide the necessary industrial inputs. The National Tariff Policy 2025-2030 is a step in the right direction, but more needs to be done to achieve deeper trade integration.

Improved trade engagement with the ASEAN region, for example, could provide impetus for greater participation in GVCs. Consequently, higher levels of trade openness would allow the expansion of efficiency-seeking domestic and foreign investment.

A more open economy geared towards global participation in the value chain will, in turn, attract long-term and sustainable investment in manufacturing. A vibrant trade policy based on deeper integration is essential if Pakistan is to become a viable destination for foreign investment.

The author is Assistant Professor of Economics and Research Fellow at CBER, Institute of Business Administration, Karachi. He also chairs the Economic Advisory Group.