The State Bank of Pakistan (SBP) is expected to adopt a measured approach to reducing the policy rate, despite significant room created by declining inflation. The Monetary Policy Committee (MPC) is scheduled to meet on Monday to announce its decision on the new policy rate, and the debate over the scale of the potential rate cut has intensified among various stakeholders.
Headline inflation, as measured by the Consumer Price Index, fell sharply to 4.9% in November, leaving the real interest rate at a highly positive 10%, given the current policy rate of 15%. This decline offers substantial space for rate cuts, but analysts anticipate the SBP will avoid drastic reductions in favor of a more conservative monetary policy.
Expectations from different sectors vary widely. Financial analysts predict a rate cut of 200 to 300 basis points (bps), while trade and industry representatives are advocating for a more aggressive reduction of 400 to 500 bps. Business leaders argue that such a cut is crucial to stimulate economic growth, which remains alarmingly sluggish, adversely affecting job creation and poverty levels. However, financial experts caution that a steep reduction to single-digit rates could destabilize the banking system and risk reigniting inflationary pressures.
The argument for a significant policy rate cut is further bolstered by projections that December inflation will decline to 3.5% to 3.9%, creating additional room for monetary easing. However, the finance minister recently signaled that the reduction may not exceed 300 bps, reflecting a cautious stance consistent with the SBP’s historical approach.
Despite low inflation, the government has yet to adopt a pro-growth strategy, which many argue is essential to address the country’s economic woes. A joint report by the United Nations Development Programme (UNDP) and Oxford University in 2024 revealed that 47% of Pakistan’s population—approximately 95 million people—live below the poverty line. Economic stagnation, compounded by restrictive monetary policies, is exacerbating the issue.
Adding to the complexity is Pakistan’s ongoing struggle with a current account deficit, which the finance minister noted arises whenever economic growth exceeds 4%. This constraint has led to an approach aimed at maintaining a current account surplus, a key condition under the International Monetary Fund (IMF) program. As a result, the government has prioritized fiscal discipline over aggressive growth measures, leaving businesses and industries facing high production costs due to an average inflation rate of 23.5% in FY24.
The government’s strategy of curbing imports to control trade and current account deficits is further stifling economic activity. Pakistan’s reliance on imported raw materials, particularly for export-driven sectors like textiles, makes this policy especially challenging. The textile industry, which accounts for 55% of the country’s export earnings, is grappling with significant hurdles. With import restrictions in place, the sector risks disruption, as it requires at least five million bales of cotton to sustain production in FY25.
Given these dynamics, business leaders and economists stress the urgency of a pro-growth strategy supported by single-digit interest rates to revitalize trade and industry. The MPC’s decision on Monday will be closely watched, as it could shape the trajectory of Pakistan’s economic recovery in the coming months.