The Monetary Policy Committee meeting is scheduled for today. After slashing the policy rate by half in just eleven months, the State Bank of Pakistan (SBP) has kept it unchanged at 11 percent in the last four reviews. Market consensus, reflected in surveys and secondary market yields, strongly favours maintaining the status quo.
However, some treasury heads at banks believe the SBP might deliver a surprise cut of 50-100 basis points. “If rates need to be cut in FY26, the only realistic window is December or January,” remarked one seasoned market player.
A 50-100 bps cut could serve as a face-saving measure and generate positive headlines. Beyond that, however, its impact on growth would likely be limited, while risks of dollarization and currency slippage would rise, potentially undermining the critical objective of building foreign exchange reserves to adequate levels.
That said, inflation is undeniably declining. It averaged 3.4 percent over the last 12 months, largely due to a favourable base effect, and is expected to remain contained even after the base effect neutralizes, with analysts forecasting 7-8 percent over the next 12 months. The latest reading stands at 6.1 percent. On a forward-looking basis, real interest rates are thus 3-4 percent positive. The IMF has acknowledged that “an appropriately tight monetary policy stance has been pivotal in reducing inflation and should be maintained to ensure inflation remains anchored within the SBP’s target range.” One could argue that even a 50-100 bps reduction would keep the stance appropriately tight.
The key lies in sending the right signals to the market. There has been subtle softening in the SBP’s communication from September to October. In September, uncertainty about flood impacts on inflation led to a more hawkish tone with one committee member even voting for a 50-bps hike. By October, data revealed lesser impacts from floods on both growth and inflation, though concerns lingered over global commodity prices.
Now, global commodity outlooks are bearish, with oil likely to hover around $60-$65 per barrel. Food prices, especially of wheat, are normalizing, and seasonal dips in perishables are evident, providing comfort on the inflation front. Does this warrant a rate cut today?
The IMF has also emphasized improving central bank communication to enhance monetary policy effectiveness. This is crucial, alongside building SBP reserves, currently exceeding $15.5 billion, the highest since March 2022. Are reserves sufficient to signal growth support?
Historically, in the last cycle, they plummeted from a $20 billion peak to a low of $3 billion in under two years, showing how quickly shocks can erode gains.
A prudent approach, therefore, is for the SBP to communicate that a tight monetary stance is essential to anchor inflation expectations at 5-7 percent (the SBP’s target) and build reserves toward $23 billion by June 2027 (aligned with IMF goals).
Much remains ahead, with the outlook dependent on exchange rate policy. The SBP has been buying in the interbank market, but momentum is waning. Without sustained investment inflows, building reserves risks piling on more debt. Thus, maintaining high real rates and a competitive (undervalued) currency has historically anchored inflation expectations more effectively.
It is wise for the SBP to avoid getting carried away by marginal improvements and prioritize sustainability. Some advocate single-digit rates, but historically, Pakistan’s rates were only that low when US rates neared zero. Today, with Fed rates at 3.5-3.75 percent, the historic spread between US and Pakistan rates (short- and long-term) is narrower than the 15-year average.
Any sharp domestic rate decline would pressure the PKR to depreciate. Currently, the interbank market is calm, with the PKR appreciating gradually against the USD. However, the REER exceeds 100, rendering exports less competitive while cheapening imports. Exporters sell forward, importers borrow abroad. Coupled with the upcoming high-remittance season (February-May) and no immediate external pressures, this calm could tempt a surprise cut.
Yet such a move risks confusing markets, sparking expectations of further easing, and building PKR pressure in the April-June quarter, when inflation may rise to 9-10 percent (base effect) amid scheduled debt repayments. Reversing course could erode the SBP’s hard-earned credibility.
Moreover, monetary easing transmission to demand takes 6-18 months. Better to wait six more months, observe another wheat harvest’s impact on food inflation, and assess the next federal budget’s tax measures before shifting stance.
While easing risks are lower now, and a New Year surprise remains possible, prudence demands caution. The right monetary approach calls for prudence and patience. In Pakistan’s fragile recovery, this wisdom rings especially true. Sustaining stability today ensures sustainable growth tomorrow.
Copyright Business Recorder, 2025
Ali Khizar is the Director of Research at Business Recorder. His Twitter handle is @AliKhizar