The impact of the external shocks on Pakistan’s development and on the accumulation balances of institutional sectors during the past two decades is quite well known. The shifts in the accumulation balances of institutions are invariably accompanied by changes in the nature and the magnitude of the claims placed with the fmancial system and with the rest of the world. At present, little is known about the nature of these changes, during this period, nor about the financial interdependence and the interaction among the private, the public and the external sectors of the economy. The growing financial problems of the country require a proper appreciation of the changing importance of different instruments in the debt portfolio of the government and other institutions and of the way capital formation is financed. A number of studies have used the flow-of-funds accounts framework to analyse the financial problems of developing countries, for example, [Jansen (1989); Roe (1985) and Bhatt (1972)]. In Pakistan, however, this subject has not received much attention. This paper is an attempt to fill this vacuum. It describes sectoral interactions within a flow-of-funds accounts framework, and distinguishes various channels through which sectoral accumulation balances come to an equilibrium by financial flows: intermediation through the formal banking system, direct capital transfers between institutions, government deficit fmancing from borrowing etc. Within this framework the impact of the changes in investment or in the federal deficit are traced to changes in the fmancial behaviour of the other sectors. The paper gives a presentation of the flow-of-funds accounts designed to understand the mechanics of financing investment and the government deficit. And helps to answer questions like what are the components of the federal deficit…………….