Transition to a digital financial ecosystem

Pakistan’s economy remains predominantly cash-driven, with about 85% of transactions occurring in physical currency. This reliance on cash leads to inefficiencies, tax evasion, and the thriving informal economy, constituting more than 40% of the nation’s GDP. Although there has been some decline in cash usage in Point-of-Sale (POS) systems from 84% in 2019 to 78% in 2023, the informal economy and cash dependency continue to undermine growth and financial inclusion. Pakistan’s tax-to-GDP ratio is alarmingly low at 9.5%, primarily due to the cash economy’s role in tax evasion and lack of traceability. The banking sector’s credit-to-GDP ratio is also low at 9%, making it difficult for small and medium enterprises (SMEs) to access formal financing. Informal financing sources, such as high-interest loans from informal lenders, deepen financial vulnerabilities. A portion of the population remains unbanked. Cultural preferences for cash and distrust in formal banking institutions limit access to financial services. Small businesses, which operate largely in cash, find it difficult to establish credit histories, hindering their ability to secure formal credit and limiting their growth potential. Cash transactions facilitate illegal activities, such as money laundering and terrorist financing, which are difficult to trace, attracting international scrutiny. The reliance on cash complicates inflation control and monetary policy, as large amounts of money circulate outside the formal banking system, weakening the central bank’s ability to manage liquidity. Cash handling increases the risk of theft, fraud, and operational inefficiencies, especially for businesses that deal with large sums of money. Record-keeping and transaction reconciliation are time-consuming. Countries like China and India have demonstrated how digital payments can transform economies. The successful implementation of India’s Unified Payments Interface (UPI) has not only boosted digital transactions but also improved tax compliance and economic transparency. In Pakistan, government initiatives like the Raast payment system aim at facilitating digital transactions and reducing cash dependency. However, adoption remains slow due to various barriers, including infrastructural issues, limited awareness, and resistance from small businesses and consumers who fear digital fraud or additional transaction fees. Expanding digital infrastructure, particularly in rural areas, is critical to ensuring accessibility to digital financial services. Mobile banking and internet access should be prioritized. Offering tax incentives, subsidies, and other benefits for businesses adopting digital payments can encourage the shift from cash transactions. Public awareness campaigns focused on the security, efficiency, and convenience of digital payments can address cultural resistance and increase adoption. Targeted educational initiatives can improve financial literacy and address concerns over fraud and data security. Strengthening cybersecurity measures and consumer protection laws will help build trust in digital financial systems. Encouraging small businesses to formalize their operations through simplified registration processes and microfinance options can help integrate them into the digital economy. Formalizing the informal economy can increase tax revenues, improve transparency, and facilitate access to formal credit. Enforcing existing regulations, such as mandatory digital invoicing for large transactions, and introducing new ones can reduce cash-based business transactions. Collaboration between the government, financial institutions, and fintech companies is essential for creating a comprehensive digital payment ecosystem. Penalties for non-compliance, along with incentives for digital payment adoption, will help accelerate the transition. Transitioning to a digital economy is both a technological and cultural shift for Pakistan. The integration of digital payment systems is essential for overcoming the inefficiencies of the cash-based economy, reducing financial exclusion, and addressing security challenges. A concerted effort involving infrastructure development, policy changes, public education, and regulatory enforcement can drive this transformation. By embracing digital financial systems, Pakistan can unlock its economic potential, improve transparency, and create a more inclusive and resilient financial ecosystem. While the journey is complex, the rewards of a modern, efficient, and transparent financial system are substantial.