EDITORIAL: The SBP (State Bank of Pakistan) kept the policy rate unchanged at 12 percent. The central bank has already eased the policy rate by a 1000 bps (basis points) in the last eight months, and its impact is still unfolding.
Although inflation is nose-diving, the SBP has wisely decided to stay put for the time being in view of the pressure on balance of payments (BoP). “The MPC assessed the current real interest rate to be adequately positive on a forward-looking basis to sustain ongoing macroeconomic stability,” the policy statement has noted.
It is likely that the SBP will keep the current rate at 12 percent until June at least. In the next few months, demand is expected to continue increasing due to substantial easing to date.
The fiscal situation will become clearer, and next year’s budget will be available for assessment. The global impact of the US tariff obsession will also become visible. More importantly, the SBP will have some buffers in the form of reserve building before considering another cut.
The monetary policy statement has noted various factors for adopting a cautious approach, including sticky core inflation, improving economic activity, and rising international uncertainties due to ongoing tariff wars.
However, the foremost reason is the decline in the SBP’s forex reserves due to growing pressure on the external account — both the current and financial accounts within the balance of payments.
Its forex reserves increased from a low of US$ 3 billion at the start of 2023 to reach US$ 12 billion by November 2024. This, along with a significant fall in inflation at a time when the primary fiscal surplus was being maintained, gave the SBP enough confidence to slash interest rates in large increments.
However, with reserves tapering by US$ 800 million in the last two months due to negative flows in both the current and financial accounts, the central bank appears to be taking a breather.
The SBP’s primary objective or its duty is to bring price stability and allow inflation to move within its medium-term target range of 5-7 percent. For this, external stability is key; without it, the currency could become unhinged, leading to uncontrolled inflation. Hence, stabilising the external account is paramount.
That said, core inflation remains sticky and is not declining in line with headline inflation. The rise (in 2023) and fall (in 2025) in inflation are due to high volatility in energy and food prices.
The drop in headline inflation to 1.5 percent in February was driven by a significant fall in perishable food prices. However, with core inflation remaining high, a rebound in perishable food prices could push inflation back up. To keep inflation in check, the SBP is taking a pause.
No doubt, economic activity is picking up, as reflected in high-frequency data, growing import volumes, and rising NO2 (nitrogen oxide) levels in major urban centres. However, GDP growth figures do not fully capture this momentum, as the agricultural sector remains in the negative.
The transmission of 1,000 bps in monetary easing is expected to continue over the next few months. Consumer and business behaviour is changing — risk appetite is increasing, businesses are considering BMR (balancing, modernisation, and replacement), and consumers are leaning toward discretionary spending.
These factors will put pressure on imports and inflation. The SBP’s pause is an attempt to slow down this behavioural shift. Additionally, the central bank is evaluating the fiscal situation, where tax revenues are falling short and meeting the full-year primary surplus target is becoming increasingly challenging.
Negotiations with the IMF (International Monetary Fund) on next year’s budget framework are ongoing, and the SBP would prefer to review the finalised budget before making any moves. By that time, the demand impact of easing will be more visible, and there could be some improvement in financial account inflows following a probable successful IMF review and a rating upgrade.
Once reserves are back on an upward trajectory and have crossed the SBP’s target of US$ 13 billion, another rate cut or two in 1HFY26 (first half of next fiscal year) cannot be ruled out — especially as the external situation improves due to a potential recession in the US.
Copyright Business Recorder, 2025
