The State Bank of Pakistan (SBP) has decided to maintain its key policy rate at 10.5% following the latest Monetary Policy Committee (MPC) meeting. This decision came as a surprise to many, as numerous analysts had anticipated a rate cut.
Inflation and External Sector Overview
According to the SBP’s Monetary Policy Statement, headline inflation stood at 5.6 percent in December 2025, while core inflation remained elevated at 7.4 percent. The external current account recorded a deficit of $244 million in December, contributing to a $1.2 billion deficit in the first half of the fiscal year 2026 (FY2026).
Weakness in exports was largely attributed to a significant decline in food exports, especially rice, although high-value-added textile exports showed resilience. Growth in workers’ remittances and ICT services helped mitigate the current account deficit.
Economic Growth and Domestic Demand
The MPC noted that inflation and the current account situation remained broadly stable, while economic growth prospects improved. Provisional data indicated a 3.7 percent year-on-year increase in real GDP for the first quarter of FY2026, driven by the industry and agriculture sectors.
- Auto sales, cement dispatches, petroleum product sales (excluding furnace oil), fertilizer off-take, and machinery imports showed notable growth.
- Large-scale manufacturing grew by 8 percent in October and 10.4 percent in November 2025, lifting the July-November growth to 6 percent.
- Encouraging prospects were reported for the wheat crop, supporting the commodity-producing sectors.
These developments are expected to bolster the services sector and contribute to an improved GDP growth forecast of 3.75 to 4.75 percent for FY2026, with further strengthening anticipated in FY2027.
Monetary Policy Rationale
Given the stable inflation outlook and improved economic indicators, the MPC deemed it prudent to hold the policy rate steady at 10.5 percent to maintain price stability and support sustainable growth. Consumer and business confidence has improved, with inflation expectations easing.
Additionally, the SBP’s foreign exchange reserves surpassed the end-December target, reaching $16.1 billion by mid-January 2026, supported by ongoing forex purchases.
Current Account and Fiscal Developments
The MPC expects the current account deficit to remain between 0 and 1 percent of GDP in FY2026, aided by rising worker remittances and favorable global commodity prices. Forex reserves are projected to exceed $18 billion by June 2026 and continue rising in FY2027, approaching the three-month import cover benchmark.
However, risks remain from global trade fragmentation and geopolitical uncertainties.
On the fiscal side, Federal Board of Revenue (FBR) tax collections grew by only 9.5 percent, falling short of last year’s 26 percent growth and the annual target, resulting in a revenue shortfall of Rs329 billion. This indicates a need for accelerated revenue collection in the second half of FY2026.
Despite this, contained expenditures, especially lower interest payments, have helped improve the fiscal balance and support the full-year deficit target. Still, achieving the annual primary surplus remains challenging, highlighting the importance of fiscal consolidation and discipline.
Credit Growth and Policy Adjustments
Broad money supply increased by 16.3 percent by early January, driven by stronger private sector credit and government borrowing. Private credit expanded by Rs578 billion during FY2026 up to January 9, led by sectors such as textiles, trade, chemicals, and consumer financing.
To encourage further credit growth, the SBP has reduced the average cash reserve requirement from 6.0 percent to 5.0 percent.
Global Outlook and Future Considerations
The International Monetary Fund (IMF) has slightly upgraded Pakistan’s global growth forecast for FY2026 but cautioned about risks from global tariff uncertainties and commodity price volatility.
The MPC emphasized maintaining a real policy rate that supports inflation within the 5 to 7 percent target over the medium term. It also stressed the importance of coordinated monetary and fiscal policies, alongside structural reforms aimed at boosting productivity, exports, and sustainable growth.
Market Expectations and Business Community Response
Prior to the announcement, many analysts expected a 50 to 100 basis point cut in the policy rate, influenced by easing inflation, rising foreign exchange reserves, and a stable rupee. The government’s recent reduction of cut-off yields to single digits for the first time in four years had further raised expectations.
Local business leaders had hoped for a more significant rate reduction to restore investor confidence. Following the previous 50 basis point cut, some expressed disappointment, calling it insufficient to revive the economy and boost business sentiment.
