SBP should resist the temptation to blink

The State Bank of Pakistan’s Monetary Policy Committee is scheduled to meet today to decide the policy rate. The most likely outcome is another hold at 11. 5 percent. At the last meeting, one member voted for an increase while the remaining eight favoured no change. This time, the balance may shift somewhat towards tightening, but the more consequential question is not today’s decision. It is how the SBP now sees inflation, growth and the path of monetary policy from here. The outlook has clearly deteriorated. Inflation was already back in double digits in June, while the escalation in the Iran conflict has pushed oil prices higher and worsened the external environment. Before this latest shock, most forecasts for average FY27 inflation had clustered around 7-9 percent. If petroleum prices remain elevated for several months, that assumption will become increasingly difficult to sustain. The problem is that Pakistan has left itself with limited room for adjustment. Central banks confronting external shocks typically rely on some combination of interest rates, exchange-rate movement and weaker domestic demand. Pakistan has effectively constrained one of those channels. The authorities remain committed to a tightly managed exchange rate, leaving monetary policy to absorb a disproportionate share of the burden. That choice has consequences. If the rupee is not allowed to adjust meaningfully, interest rates must remain higher than they otherwise would. Positive real rates are not simply a matter of monetary conservatism in that setting. They become the principal defence against renewed demand pressures, capital outflows and another deterioration in the external account. The costs of the exchange-rate policy are also becoming increasingly visible. The SBP’s Real Effective Exchange Rate has risen to 106. 5, its highest level since 2018. REER should not be treated as a mechanical measure of fair value, but the direction matters. The rupee has appreciated materially in real effective terms at a time when export competitiveness remains weak and the trade deficit is under renewed pressure. This is why expectations of imminent monetary easing are misplaced. Even if the Iran conflict ended tomorrow and oil prices retreated towards the low US$70s per barrel, the SBP would still have little justification for cutting rates quickly. Inflation remains elevated, external risks have increased, and the exchange rate is doing relatively little of the adjustment. The SBP has already been forced to reverse direction once. After cutting the policy rate from 22 percent to 10. 5 percent, it raised the rate again as inflation and external risks worsened. Another rapid shift back towards easing would weaken the credibility of the policy reaction function. If elevated oil prices persist and begin feeding into broader inflation, another increase before the end of the calendar year cannot be ruled out. There is, admittedly, a respectable argument for acting pre-emptively and raising rates by 50 basis points today. There are also reasons for restraint. Economic activity appears to have softened, while monetary conditions remain restrictive. A supply shock does not automatically warrant an immediate increase in rates if domestic demand is already weak and second-round inflationary effects remain contained. But those second-round effects are precisely what the SBP must now watch. Wheat and flour prices have risen sharply, while higher fuel prices will eventually work through transport, production and distribution costs. The immediate shock may be external, but its persistence will determine whether it remains a relative-price adjustment or begins feeding into underlying inflation and expectations. Financial markets appear to recognise that risk. Government bond yields suggest that investors see little prospect of near-term easing and some probability of further tightening. That is hardly surprising. A prolonged conflict in the Middle East would simultaneously raise Pakistan’s import bill, weaken global demand and keep inflationary pressures elevated. It is a poor environment in which to experiment with premature monetary accommodation. The principal counterargument is that growth should now take precedence. That would be a dangerous gamble. Investment remains weak and borrowing costs are painful, but high interest rates are not the main reason Pakistan is struggling to attract investment. Lower rates cannot compensate for weak productivity, an uncertain regulatory environment, poor export competitiveness and an economy repeatedly pushed towards balance-of-payments stress whenever domestic demand accelerates. Some optimism has instead shifted towards reports that Pakistan has requested a US$10 billion stabilisation facility from the US Treasury. Were such a facility to materialise on favourable terms, it could strengthen reserves, improve Pakistan’s credit profile and reduce near-term external financing risks. But there is an important distinction between a possibility and a policy assumption. The comparison with Argentina is revealing. In Argentina’s case, senior US officials publicly framed additional support in strategic and political terms before assistance materialised. There has so far been no comparable on-record indication from the US Treasury regarding Pakistan’s reported request, much less clarity on its likelihood, structure or timing. Monetary policy cannot sensibly be calibrated around speculation. More fundamentally, the very need to seek another stabilisation facility after years of painful adjustment should prompt uncomfortable questions. Pakistan has generated primary fiscal surpluses, maintained high real interest rates and suppressed domestic demand at considerable economic cost. Yet investment remains anaemic, exports remain weak and external stability continues to depend heavily on remittances and official financing. That suggests the missing ingredients lie elsewhere: deeper fiscal reform, regulatory reform, stronger export competitiveness and a sustained revival of private investment. Monetary policy cannot deliver these outcomes. Nor should it be expected to compensate indefinitely for an exchange-rate policy that limits adjustment through the currency. The sensible course for now is therefore to hold the policy rate at 11. 5 percent while maintaining a clearly hawkish bias. The SBP should make it clear that easing is not imminent and that further tightening remains available if higher energy and food prices begin feeding materially into core inflation and expectations. If maintaining restrictive interest rates becomes too costly for investment and domestic activity, Pakistan does have another adjustment mechanism available. The exchange rate should be allowed to do more of the work, so that interest rates no longer have to do almost all of it. Copyright Business Recorder, 2026

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