The State Bank of Pakistan’s (SBP) decision to reduce the policy rate by 200 basis points to 13 percent marks another step in its calibrated effort to balance inflation control with growth stimulation. While this move offers some relief to businesses long clamoring for more aggressive monetary easing, it underscores the delicate tightrope the central bank must walk in its policy decisions.
At first glance, the cut is a welcome reprieve. Inflation, as measured by the Consumer Price Index (CPI), has fallen sharply to a 78-month low of 4.9 percent. This creates significant headroom for rate reductions, especially with the real interest rate sitting at a strikingly positive 10 percent. However, the SBP’s cautious approach—opting for a moderate reduction rather than the drastic cuts of 400-500 basis points demanded by the business community—is a prudent course of action, given the underlying complexities of Pakistan’s economic landscape.
Core inflation remains persistently high at 9.7 percent, reflecting entrenched price pressures even as headline inflation recedes. Furthermore, inflation expectations among consumers and businesses are far from stable. This dichotomy suggests that while the broader inflation picture has improved, the risks of resurgence cannot be discounted. A premature or overly aggressive easing of monetary policy could undermine recent gains in price stability, particularly in a volatile macroeconomic environment.
The approach the SBP should be taking, and it seems to be doing so, is cautious optimism. There are improving growth prospects, citing upticks in high-frequency economic indicators and increased credit to the private sector. Yet, the broader economic backdrop remains challenging. Growth projections for FY25 linger at a modest 2.5 to 3 percent, reflecting subdued economic activity. The steep decline in CPI may be less a harbinger of sustained disinflation and more a symptom of economic stagnation.
As much as businesses require lower borrowing costs to spur investment, the central bank cannot lose sight of the fragility of the financial system. Reducing interest rates too aggressively risks destabilizing banks’ balance sheets and undermining confidence in financial markets. The SBP’s cautious approach thus reflects an acknowledgment of these constraints.
While there is room for further rate cuts, the SBP would do well to avoid excessive optimism. The economy’s structural vulnerabilities demand a measured approach. Inflation volatility, financial system stability, and global economic uncertainties all warrant careful consideration. A steady, incremental easing of monetary policy is preferable to a rushed descent to single-digit rates that could reignite inflation or destabilize financial markets.
Ultimately, the success of this monetary easing cycle depends on complementary fiscal and structural reforms. Without addressing Pakistan’s deeper economic challenges—ranging from low productivity to a persistent current account deficit—monetary policy alone cannot deliver sustainable growth.
