The shadow economy in Pakistan, valued at a staggering $457 billion and accounting for over 40 per cent of the country’s GDP, operates as a paradox. While it sustains millions of workers and small businesses who rely on informal channels, it simultaneously deprives the state of critical revenue and undermines fiscal stability. This sprawling informal sector highlights systemic inefficiencies, weak governance, and socio-economic inequities. More alarmingly, it is intricately linked to global concerns such as money laundering and terrorism financing, drawing attention from institutions like the IMF, World Bank and FATF. Addressing this pervasive problem is not merely an economic imperative but a geopolitical necessity.
Historically, Pakistan’s shadow economy grew out of necessity. After independence in 1947, with limited industrialization and inadequate financial infrastructure, informal trade and undocumented labour became survival mechanisms. Over time, however, this informal economy grew unchecked, fueled by decades of political instability, weak enforcement, and external crises. During the Afghan War in the 1980s, the influx of refugees and unregulated cash inflows fostered the rapid expansion of systems like hawala. These informal financial networks became deeply embedded in Pakistan’s economic fabric, facilitating cross-border transactions and bypassing formal banking channels. The 1990s, marked by economic mismanagement and international sanctions, saw further entrenchment of informality. By 2024, the shadow economy had outpaced the formal economy, which is valued at $340 billion, reflecting chronic governance failures.
The Federal Board of Revenue (FBR) estimates that over 75 per cent of Pakistan’s workforce operates informally, with around three million businesses remaining unregistered. This deprives the government of approximately $10 billion annually in tax revenue – funds that could drastically reduce fiscal deficits, invest in public infrastructure, and expand healthcare and education. Furthermore, workers in the informal economy are excluded from basic protections such as pensions, health insurance, and legal safeguards. This exclusion perpetuates economic inequality and leaves millions vulnerable to exploitation. Pakistan’s shadow economy has global repercussions. Informal financial networks such as hawala, which handle billions of dollars annually, are not just enablers of tax evasion but also facilitators of money laundering and terrorism financing. The Financial Action Task Force (FATF), an international watchdog, placed Pakistan on its grey list in 2018, citing deficiencies in its anti-money laundering (AML) and counter-terrorism financing (CTF) frameworks. Although Pakistan exited the grey list in 2022 after implementing targeted reforms, the underlying vulnerabilities persist. The inability to regulate informal financial flows continues to pose risks to international financial stability and global counter-terrorism efforts.
Raast has already attracted 20 million users, but its reach must be expanded in rural and underserved areas.
FATF’s grey-listing had significant economic implications for Pakistan, limiting its access to international financial markets and deterring foreign investment. To meet FATF’s demands, Pakistan introduced a series of legislative and regulatory reforms, including amendments to its AML laws and increased scrutiny of financial institutions. While these efforts earned the country a reprieve, enforcement remains a critical challenge. Corruption, limited institutional capacity, and a lack of coordination among enforcement agencies undermine the effectiveness of these measures.
Globally, shadow economies are a common challenge, and countries like India, Indonesia, Turkey, Greece, and Mexico provide valuable lessons. India’s demonetization drive in 2016, which invalidated high-denomination currency notes, aimed to curb undeclared wealth and boost digital payments. Although it caused short-term disruptions, the policy succeeded in bringing hidden wealth into the banking system and increasing tax compliance. Indonesia, meanwhile, adopted a more incentive-based approach through its 2016 tax amnesty program, which encouraged individuals to declare $350 billion in hidden wealth by offering reduced penalties. This initiative generated $11 billion in additional tax revenue and enhanced trust in public institutions.
Turkey’s approach focused on leveraging technology. The introduction of mandatory e-invoicing and e-bookkeeping systems increased transparency and significantly reduced opportunities for tax evasion. Similarly, Greece tackled its shadow economy by mandating electronic payments for high-value transactions and launching public awareness campaigns. Mexico, with its Régimen de Incorporación Fiscal (RIF) program, simplified tax compliance for micro-enterprises while offering social security benefits and tax incentives. Over five years, this initiative formalized four million businesses, significantly expanding Mexico’s tax base and improving worker protections.
For Pakistan, these examples highlight the importance of adopting a multi-faceted strategy. Simplifying tax structures is a critical starting point. High compliance costs and complex regulations discourage businesses from registering and foster a culture of evasion. Introducing flat tax rates for micro-enterprises and offering tax holidays for newly formalized businesses could reduce barriers to compliance and increase state revenues. Additionally, Pakistan could consider a tax amnesty program tailored to its socio-economic realities, encouraging individuals and businesses to declare undeclared assets without fear of punitive action.
Technology can play a transformative role in addressing the shadow economy. Blockchain technology, with its transparency and tamper-proof systems, offers a promising solution for tracking financial transactions and ensuring accountability. By integrating blockchain into tax collection and public finance management, Pakistan can reduce corruption, enhance trust in public institutions, and improve enforcement. Expanding digital financial services, such as the Raast instant payment system, is another critical step. Raast has already attracted 20 million users, but its reach must be expanded, particularly in rural and underserved areas, where financial literacy and access to technology remain limited.
Enforcement mechanisms must form the backbone of Pakistan’s reform efforts. Regulatory bodies such as the FBR and State Bank of Pakistan (SBP) require greater autonomy, resources, and technological capabilities to monitor compliance effectively. Strengthening institutional frameworks is essential for enforcing AML laws, increasing tax compliance, and regulating high-risk sectors like real estate, gold trading, and informal banking. Adopting a risk-based approach to enforcement can maximize impact by prioritizing sectors most prone to informality and illicit activities.
Public-private partnerships can further strengthen enforcement. Collaborating with banks, Fintech companies, and industry associations can improve monitoring and compliance. For instance, financial institutions can be incentivized to report suspicious transactions, while Fintech firms can help digitize informal businesses. These partnerships not only expand the government’s enforcement capacity but also foster a culture of compliance among businesses and consumers. Rebuilding public trust in governance is perhaps the most significant challenge. Decades of corruption, inefficiency, and poor service delivery have eroded confidence in state institutions, driving businesses and workers into the informal sector. Transparent governance, accountability measures, and visible improvements in public services are essential for restoring trust. Public awareness campaigns showcasing the tangible benefits of formalization – such as access to credit, legal protections, and social security – can encourage voluntary compliance. The risks of inaction are severe. A thriving shadow economy undermines Pakistan’s fiscal stability, restricts foreign investment, and perpetuates economic inequality. It also poses significant threats to national security and regional stability.
Pakistan’s shadow economy is a paradox. Addressing this duality requires bold leadership, innovative policies, and sustained commitment from all stakeholders. By leveraging international best practices, adopting technological solutions, and prioritizing fiscal reforms, Pakistan can transform its shadow economy from a liability into a cornerstone of sustainable growth. The journey toward formalization will not be easy. It demands political will, institutional reform, and a fundamental shift in societal attitudes. However, the rewards of success – greater fiscal stability, improved public services, and enhanced international credibility – are too significant to ignore.
The writer is a financial expert and can be reached at jawadsaleem.1982@gmail.com. He tweets @JawadSaleem1982.