ISLAMABAD: Fitch Ratings on Monday projected improved prospects for Pakistan`s banking sector, citing stabilising macroeconomic indicators, falling inflation, and a return to economic growth. The global credit agency expects Pakistan`s GDP to grow by 3.5pc in FY27, with inflation averaging 5pc a significant shift from the turmoil and high inflation of recent years.

In a brief commentary, Fitch said banks are wellpositioned to capitalise on improving operating conditions as macroeconomic headwinds ease. It noted that stronger business volumes, driven by economic recovery and better credit demand, would support banking performance in the near term.

The outlook follows Pakistan`s upgraded sovereign credit profile, with Fitch raising its Long-Term Issuer Default Rating (IDR) to `B-`/Stable from `CCC+` in April 2025. The upgrade reflects ongoing reforms, fiscal improvement, and greater economic resilience.

The agency pointed out that consumer price inflation, which had peaked at 38pc in May 2023, eased to 4.1pc in July 2025, aided by a halving of the policy rate since May 2024 to 11pc. Coupled with a more stable external position marked by reduced currency volatility and current account surpluses this has laid the groundwork for a sustained recovery.

Fitch projected that lower interest rates and improved macro fundamentals would spur privatesector credit demand and steady growth in loans and deposits. This is expected to reduce the banking sector`s reliance on public-sector lending, with privatesector credit currently at a cyclical low of 9.7pc of GDP (2024). Reforms will be critical to deepening credit penetration and enabling greater commercial lending activity.

However, the agency cautioned that despite improvements, Pakistan`s operating environment remains weak. Banks` creditworthiness will continue to be closely tied to the sovereign, due to their large holdings of government securities and exposure to statelinked entities.

The report noted that Pakistani banks have remained financially resilient. The sector`s impaired loan ratio improved to 7.1pc by March 2025, down from 7.6pc at end-2023, supported by strong loan growth of 26pc. Fitch expects this pace to moderate, but asset quality should remain stable, helped by improved repayment capacity amid lower interest rates.

Return on average equity fell to 20pc in Q1 2025 from 27pc in 2023, reflecting tighter net interest margins and higher operating costs due to inflation. These pressures were partially offset by stronger non-interest income. Fitch expects further margin pressure, but overall earnings should remain supported by loan expansion and treasury operations.

The system`s capital adequacy ratio (CAR) rose to a decade-high of 21pc by March 2025, reflecting strong internal capital generation. While the CAR may ease slightly if higher-risk private-sector lending expands, it is expected to stay well above the 11.5pc regulatory minimum.