The Monetary Policy Committee is likely to keep interest rates unchanged today. Market rates suggest a cut—down by almost 90 basis points since the last policy announcement—but pre-policy surveys lean toward a status quo. Until last week, the broader expectation was for a 50 bps cut; however, the recent escalation in the Iran-Israel conflict has pushed oil prices upward, prompting calls for a more cautious stance.
Inflation appears to have bottomed out. Most on the street expect FY26 inflation to settle between 6–7 percent, while both the government and IMF project it at 7.5 percent. That said, there are upside risks if oil prices remain above $75/barrel. The government has budgeted Rs1.5 trillion from the Petroleum Levy (PL) in FY26, implying a likely increase in the levy. Higher fuel prices could spill over into food inflation, reinforcing inflationary expectations.
Higher oil and other commodity prices also exert pressure on the import bill—the external sector’s weakest link. The balance of payments is already under strain, despite a current account surplus, due to a negative financial account driven by reduced external assistance to the general government. Net external receipts are projected to shrink significantly in FY26, further tightening the balance of payments position.
Dollar liquidity remains tight in the market. Import L/Cs are being retired at a premium of over 1 percent (around Rs3/USD) to the prevailing rate. Banks are offering generous discounts to attract remittance inflows, over and above the government subsidy. The concerning part is that there is no allocation for this subsidy in FY26—unlike Rs87 billion last year—which may constrain formal remittance growth.
This makes the external account the key deciding factor. A rate cut could further strain the external position, potentially requiring currency depreciation to offset easing. Nothing fuels inflation expectations more than a weakening currency. Moreover, the government has already increased taxation on income from bank deposits and fixed-income mutual funds, reducing savers’ returns. Further monetary easing could drive marginal savers toward foreign currency holdings.
On the other hand, fiscal consolidation is underway. FY26 is expected to bring a contractionary budget, which provides some room for monetary easing. Other than higher petroleum taxes, the budget doesn't introduce many inflationary measures. However, there are evident gaps in both tax and non-tax revenue projections, and a mini-budget cannot be ruled out—potentially stoking inflation expectations later in the year.
In short, there are upside risks to the current inflation forecast. Without these risks materializing, a 1–2 percent rate cut before reaching the bottom of the cycle cannot be ruled out. But to keep inflation and economic stability within the medium-term target range of 5–7 percent, it would be prudent for the central bank to adopt a wait-and-see approach.
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