Investor confidence in Pakistan is already fragile because of repeated macroeconomic crises, political uncertainty, and governance gaps. On top of this, a very large and persistent illegal economy has become a structural risk. Smuggling, under-invoicing, counterfeit goods, and large-scale tax evasion make markets unpredictable, weaken the rule of law, and discourage both domestic and foreign investors from committing long-term capital.

This note explains how these practices erode confidence across key sectors, highlights the cigarette industry as an illustrative case, and outlines the kind of reforms that can begin to restore trust.

The Scale of the Illegal Economy

Evidence from business councils and independent institutes shows that Illegal trade in Pakistan is not a marginal problem. The combined value of smuggling, under-invoicing, mis-declaration, counterfeiting, and adulteration has been estimated at about 20 percent of the formal economy, with the associated tax loss reaching several trillion rupees annually.

Other recent work by policy think tanks and international partners suggests that Pakistan loses roughly Rs 750 billion every year in tax revenue due to Illegal trade and smuggling alone, with tobacco and petroleum repeatedly identified as major problem sectors.

Beyond the absolute numbers, Pakistan now ranks poorly on the Global Illegal Trade Index, placed 101 out of 158 countries, which sends a clear signal to investors that enforcement and border controls remain weak compared with peers.

These figures together depict an environment in which the state’s rules are not applied evenly. For investors, this translates directly into higher perceived risk, weaker profit visibility, and doubts about the long-term viability of formal, tax-paying business models.

How Illegal Practices Destroy Market Confidence

In any sector where tax-evading or smuggled products capture a significant share of the market, legitimate firms face three linked problems.

First, price competition becomes distorted. Operators who evade customs duties, sales tax, or excise can undercut compliant firms by margins that no efficiency gain can match. This creates a structural penalty for those who invest in scale, technology, and compliance.

Second, policy becomes less credible. When governments respond to revenue shortfalls by raising nominal tax rates rather than closing enforcement gaps, investors infer that the formal sector will keep paying for leakages created elsewhere. This expectation of future, often ad hoc, tax measures undermines the business case for further capital expenditure. Studies on Pakistan’s investment climate repeatedly stress that unpredictable regulation and weak enforcement are central reasons why capital formation lags behind potential.

Third, the rule of law itself comes into question. When investors see that large illegal supply chains operate openly in fuel, cigarettes, real estate, beverages, tea, and electronics, they reasonably ask what other forms of informal power and influence are at work. That perception feeds into higher risk premiums, tougher internal approvals for greenfield projects, and a preference for short-term trading over long-term industrial investment.

Cigarette Industry: A Clear Illustration of Distorted Incentives

Few sectors illustrate this dynamic as clearly as cigarettes. The cigarette industry is one of Pakistan’s largest tax paying sectors and a top contributor to federal excise duty. FBR data show that in FY 2023-24, cigarettes accounted for about 41 percent of total federal excise duty on major goods, and total tax collection from tobacco has been in the range of Rs 270–300 billion per year.

At the same time, multiple studies and official statements now converge on a striking fact: Pakistan is losing more in tobacco tax due to Illegal trade than it actually collects from the legal segment. Estimates of annual revenue loss from illegal cigarettes range from over Rs 300 billion to about Rs 415 billion.

Recent briefings have highlighted that only two fully compliant multinational companies, with roughly 44 percent of the market, pay close to Rs 290–300 billion in taxes, while more than 40 local manufacturers, controlling the remaining 56 percent, contribute only about Rs 5 billion.

For investors observing this pattern, three messages are unavoidable. Law-abiding firms are penalized relative to violators. Tax policy has created incentives that push consumers toward illegal products. And enforcement has not kept pace with the sophistication of the Illegal networks, despite tools such as track-and-trace and special operations at processing plants. This combination sends a discouraging signal to any investor who considers entering, expanding, or modernizing operations in the sector.

Spillover Across Petroleum, Real Estate, and Other Key Sectors

Illegal practices in cigarettes do not exist in isolation. Similar patterns are evident in petroleum products (fuel adulteration, smuggling across borders, and non-payment of duties), real estate (under-declaration of transaction values and large volumes of undocumented capital), beverages, pharmaceuticals, tea, and consumer electronics.

In each of these sectors, the presence of parallel illegal supply chains has several common effects. Compliant firms face depressed margins and lower returns on investment. New entrants hesitate because they cannot reliably model how deeply informal networks are entrenched. Serious foreign partners worry about reputational risk if their brands become associated, even indirectly, with markets where counterfeit or tax-evaded products dominate.

Over time, capital responds rationally. Rather than investing in new manufacturing, research, or distribution capacity, many firms limit themselves to survival strategies: shrinking formal footprints, outsourcing to informal intermediaries, or shifting capital abroad. This is exactly the opposite of what Pakistan requires for sustainable growth and job creation.

Reforms That Can Rebuild Investor Trust

Rebuilding investor confidence in this context requires a visible, multi-year commitment to shrinking the illegal economy and protecting formal sector investment.

A first priority is consistent enforcement across sectors. When governments deploy tools such as IP-based CCTV in factories, track-and-trace systems, and dedicated enforcement units at critical nodes like fuel depots or green leaf threshing units, they must sustain these measures and ensure that violators face predictable penalties. Sporadic crackdowns followed by long periods of neglect only deepen investor cynicism.

A second priority is alignment of tax policy with enforcement capacity. Very high nominal rates, combined with weak enforcement, invite evasion. Reasonable, stable rates, combined with strong monitoring and low tolerance for non-compliance, are more likely to widen the tax base without encouraging the growth of illegal markets. This is especially relevant in sectors like cigarettes and petroleum, where large rate differentials between legal and illegal products create arbitrage opportunities at every stage of the supply chain.

A third priority is transparency. Publishing regular, credible data on sectoral tax collection, estimated leakages, and enforcement actions can reassure investors that the problem is being confronted systematically. Civil society and platforms such as ACT Alliance can support this effort by documenting losses, elevating the voices of compliant businesses and farmers, and keeping public attention focused on the cost of inaction.

When investors see that rules are applied fairly, that illegal operators face real consequences, and that policy is guided by evidence rather than ad hoc pressure, they respond. Capital that is currently on the sidelines, or diverted into informal activities, can begin to move back into productive, tax-paying sectors.

From Illegal Losses to a Confidence Dividend

Pakistan cannot afford an economy where Illegal activity is allowed to sit at the heart of major sectors. The current situation, in which a large tax-paying cigarette industry and other formal businesses are undercut by illegal operators, is not merely unfair; it is a structural drag on investment, employment, and long-term growth.

Treating Illegal trade and tax evasion as central economic and governance threats, rather than as peripheral law-and-order issues, is essential. Serious, sustained action would not only recover lost revenue. It would also send the clearest possible message to investors, domestic and foreign, that Pakistan is prepared to protect those who play by the rules and to build a future anchored in legality, transparency, and fair competition.