Doves are in control at SBP. A 250 bps rate cut has been announced, slightly exceeding market expectations. Some votes, primarily from external economists within the monetary policy committee, had suggested a cut of 150-200 bps; however, the reduction landed at 250 bps, bringing the rate to 15 percent. Further cuts may be anticipated.

Macroeconomic indicators are improving, particularly on the debt and external liabilities side. Over the past two years, public debt has slightly decreased, with a greater share now represented by low-cost, long-term multilateral loans, while market-based loans have declined. The low external financing requirement is also helping stabilize the currency.

Lower-than-expected inflation and a stable currency amid fiscal consolidation have bolstered SBP’s confidence, accelerating the pace of easing. No major risks have been highlighted by SBP, implying that easing may continue. However, after today’s substantial reduction, bringing the policy rate down to 15 percent from 22 percent just a few months ago, future rate cuts are likely to be smaller—around 100-150 bps in December, with similar reductions expected until SBP finds the rate adequate.

SBP’s positive outlook on inflation is justified, as inflation is now expected to be significantly lower than the earlier forecast of 11.5-13.5 percent. Additionally, SBP’s view on improved external accounts and a stabilized currency appears accurate; the central bank has been purchasing dollars while private sector players have been gradually converting to PKR. This trend is reflected in the simultaneous reduction of foreign reserves held by banks and an increase in SBP reserves. Improvements in the NFA-to-NDA ratio and reductions in forward/swap liabilities further support this outlook. The current account deficit is projected to remain below one percent of GDP, making external financing very manageable.

However, SBP’s confidence in the rapid revival of growth and private credit uptake may be slightly misplaced. The economic outlook remains challenging, and growth is not gaining much traction. Recent private credit growth by banks has mainly been a response to avoiding higher taxes linked to low advance-to-deposit ratios (ADR). This has created distortions that are likely to normalize by early 2025.

There remains concern within SBP regarding import growth, leading to a continued cap of Rs3 million on auto loans. This is a distortion SBP has chosen to maintain. Policy rates are being eased as market yields have declined sharply, which could have otherwise rendered the policy rate ineffective; making banks unwilling to borrow through OMO to lend to the government, which had created a negative spread in the short term. The 250 bps cut aims to bridge this gap.

Attention should also be given to import demand and reserve buildup. Roughly $800 million in T-Bill investments from foreign investors currently support reserves, and SBP is likely to seek an increase in this figure. These inflows are driven by high positive real interest rates, and a rapid easing could trigger outflows that would pressure the currency—an outcome SBP seeks to avoid.

Additionally, FE loan financing has picked up, and excessive rate cuts could place undue pressure on the currency. Favorable flows, largely attributable to high positive real rates, have positively impacted M2, with a shift toward NFA. This dynamic aids in controlling inflation, supporting SBP’s confidence in further easing. However, caution is warranted.

It is important to consider the past two years’ economic trajectory and allow stabilization efforts to take hold. Fiscal consolidation may not persist in the coming year, and an abrupt growth surge in FY26 could risk reversing the progress made. Therefore, easing should proceed cautiously.