The State Bank of Pakistan (SBP) is once again at the center of Pakistan’s economic debate as pressure mounts from policymakers in Islamabad and Rawalpindi to deliver on two conflicting goals: lowering interest rates while simultaneously strengthening the rupee. Economists argue that such an approach is not only unrealistic but could also undo the fragile gains achieved in recent months, warning that these attempts are akin to “defying gravity.”
Recent interventions by the SBP have helped the rupee post marginal gains against the US dollar. However, market watchers caution that this strategy is unsustainable, as history shows little long-term change. In March 2023, the rupee traded at 284 against the dollar, compared to 282 today—illustrating that currency stability has largely stemmed from the SBP’s bold move to raise policy rates to 22 percent and maintain positive real interest rates. This policy helped attract capital inflows and reduced speculative activity in the currency markets.
Another impact of the SBP’s stance was the significant reduction in currency in circulation (CIC), which fell to zero in FY24. Yet, with rates slashed in half over the past year, CIC has begun rising again, undermining incentives for households and businesses to keep money in the banking system. The trend also risks fueling inflationary pressures, particularly as commodity hoarding—previously discouraged by high real interest rates—returns with visible signs in markets such as sugar and wheat.
Economists argue that while demand-side inflationary pressures are resurfacing, SBP’s recent decision to hold policy rates steady was both timely and prudent. A loosening stance, they warn, could strain foreign exchange markets where supply has already tightened. Banks have been offering premiums to attract remittances, diverting flows from informal channels, but this effort relied heavily on a government subsidy. Initially budgeted at Rs 80 billion in FY24, subsidy claims surged to Rs 200 billion, forcing its rollback in FY25. As a result, many banks, having absorbed significant losses earlier in the year, are reluctant to continue without clearer policy direction.
This uncertainty has knock-on effects for trade finance. Analysts highlight the risk that banks could adopt a more selective approach in opening Letters of Credit, similar to the situation in FY23, which constrained imports and hampered business activity. Adding to the complexity, multiple exchange rates are emerging, with different rates offered by banks and exchange companies, further distorting market signals.
Experts stress that the SBP’s independence is critical at this juncture. Artificially propping up the rupee, they argue, would erode the credibility built through reserve accumulation of $12–14 billion over the past 18 months. A market-driven exchange rate, coupled with sufficiently high real interest rates, remains the most sustainable strategy to safeguard stability.
The broader lesson from the 2022–23 crisis remains fresh: premature monetary loosening can unravel hard-won gains. While lowering interest rates is an important policy objective, it should be achieved through fiscal consolidation and structural reforms, not through coercion of the central bank. Clear communication from the SBP, paired with consistent signals from the finance ministry, is essential to build market confidence.
Analysts underline that Pakistan has already witnessed a halving of interest rates within a year, and early warning signs are emerging in inflation and exchange markets. Until stronger capital inflows materialize, the SBP’s best option is to stay the course—holding real rates high, avoiding premature easing, and keeping the economy anchored on a stable trajectory.
Source: Business Recorder – https://www.brecorder.com/news/40378314/defying-gravity-why-sbp-must-hold-its-ground