Moody’s Investors Service has upgraded Pakistan’s banking sector outlook from stable to positive, reflecting gradual economic recovery and stronger confidence in the financial system.

The move highlights improving business conditions and supportive government reforms.

According to Moody’s, the positive outlook reflects a gradually improving operating environment for Pakistan’s banking sector. The agency emphasized that government reforms have strengthened confidence and spurred economic activity, setting the stage for more stable financial performance over the next 12 to 18 months.

While challenges remain, particularly regarding asset quality and profitability, Moody’s expects banks’ overall performance to remain steady.

Moody’s noted that roughly half of Pakistani banks’ assets are in government securities. This close link means the banking sector’s health is largely aligned with the government’s fiscal outlook. However, the agency cautioned that Pakistan’s long-term debt sustainability remains uncertain due to fiscal vulnerabilities and external risks.

Growth and inflation outlook

The agency projects Pakistan’s real GDP growth to rise to 3.5% in 2026, up from 3.1% in 2025. Inflation, which fell from 23% in 2024 to 4.5% in 2025, is expected to rise again to 7.5% in 2026 due to base effects.

The reduction in inflation has allowed policy rates to ease, which Moody’s says should increase loan demand. While lower rates have put pressure on margins, higher business volumes, stable costs, and non-interest income are expected to support bank profits and capital buffers.

Moody’s flagged potential pressure on agricultural production following recent floods. Despite this, industrial and services sector activity is anticipated to remain stable.

Non-performing loans (NPLs) increased after the removal of the Advances to Deposits Ratio Tax in early 2025, and as of September 2025, loans represented 23% of banking assets. However, double-digit credit growth is expected in 2026 as economic conditions improve.

The agency noted that borrower defaults, particularly in the agriculture and energy sectors, are likely to continue. Overall problem loan rates are expected to remain around 8% due to low borrowing costs.

As of September 2025, Tier One and Total Capital ratios of Pakistani banks stood at 18% and 22.1%, respectively, well above regulatory requirements. Moody’s said these strong capital buffers are likely to support the sector amid ongoing economic and sectoral challenges.