The State Bank of Pakistan (SBP) on Wednesday opted to maintain the policy rate at 11%, signaling a cautious approach despite a sharp decline in inflation and early signs of economic revival.
In a statement issued after the meeting of the Monetary Policy Committee (MPC), the central bank acknowledged that the 3.2% inflation in June was below the target range, but noted the inflation outlook had somewhat deteriorated due to larger-than-expected hikes in gas and other energy tariffs. However, it expressed confidence that inflation would stabilize within the 5-7% target range over the coming year.
Cautious Optimism
The SBP noted that the impact of previous interest rate cuts was still unfolding, and economic activity was gradually picking up. High-frequency indicators such as automobile sales, fertilizer offtake, and imports of intermediate goods and machinery show positive momentum, while Large-Scale Manufacturing returned to growth in April and May after a prolonged slump.
Encouragingly, the agriculture sector is also expected to recover in FY2026, aided by improved water availability following recent rains. Combined with a strengthening services sector, the SBP projects GDP growth between 3.25% and 4.25% for the fiscal year, up from 2.7% in FY2025.
External Sector
The MPC flagged growing concerns over the widening trade deficit, which could erode recent gains in the current account. Although the current account posted a $328 million surplus in June, taking the FY25 total to $2.1 billion, this was largely driven by strong remittances. With those expected to slow in FY26 due to a high base and changes in incentive schemes, and with exports under pressure from weak global demand and lower commodity prices, the current account is projected to fall into a small deficit of 0-1% of GDP in the coming year.
In June, Pakistan’s foreign exchange reserves crossed $14 billion, supported by inflows and a sovereign credit rating upgrade that improved investor confidence, lowered Eurobond yields, and narrowed credit default swap spreads. The SBP expects reserves to rise further to $15.5 billion by December 2025, helped by anticipated private inflows.
Fiscal and Credit Dynamics
On the fiscal front, the government exceeded its targets for primary and overall fiscal balances in FY25 through strong revenue growth. However, FBR tax collection fell short of the revised Rs. 11.9 trillion target by Rs. 200 billion, ending at Rs. 11.7 trillion. For FY26, the government aims to maintain fiscal discipline with a targeted primary surplus of 2.4% of GDP, which the MPC stressed was imperative for sustained macroeconomic stability.
In credit markets, private sector borrowing increased by 12.8% year-on-year, supported by improved economic conditions and positive sentiment. Lending was broad-based across working capital, investment, and consumer finance, with notable demand from the textile, telecom, and retail sectors.
Broad money growth also accelerated to 14%, reflecting improved foreign reserves and credit expansion. However, a recent rise in the currency-to-deposit ratio prompted the SBP to inject liquidity into the banking system, resulting in higher reserve money growth.
Inflation Outlook
June’s inflation rate of 3.2% marks a significant deceleration from earlier highs, driven by easing food prices and a slight drop in core inflation to 7.6%. However, the MPC warned of potential inflationary pressures ahead, especially from gas tariff hikes, phasing out of temporary energy subsidies, and global fuel price volatility.