The State Bank of Pakistan (SBP) has significantly lowered interest rates in recent months, aiming to stabilize the economy while supporting growth. However, with inflation risks still present and global uncertainties mounting, the central bank now faces a critical decision—should it continue cutting rates or pause to safeguard long-term stability? While economic indicators show signs of improvement, history warns against aggressive monetary easing without structural reforms.

The State Bank of Pakistan (SBP) has reduced its benchmark interest rate by 100 basis points, bringing it down to 12% from the previous 13%. This move follows growing calls for a significant rate cut to support economic conditions. Since June 2024, the central bank has progressively lowered the policy rate by a total of 1,000 basis points from 22%, making this the sixth reduction in the cycle. The decision was made after evaluating inflation trends and other economic indicators. The SBP also acknowledged improvements in remittance inflows and noted that inflation figures were expected to decline in January. However, concerns remained regarding core inflation, which continues to stay at elevated levels.

The SBP governor emphasized a cautious approach in implementing the rate cut. He pointed out the positive trajectory of remittances and exports, both of which are helping stabilize the current account. On the subject of foreign exchange reserves, he reaffirmed the central bank’s target of reaching $13 billion by the end of June. A statement from the SBP highlighted that inflation had continued its downward trajectory, aligning with earlier projections. In December, inflation stood at 4.1% year-on-year, attributed to subdued domestic demand, improved supply conditions, and a favorable base effect. The bank expects inflation to decline further before experiencing a gradual uptick in the following months. However, core inflation remains persistently high.

The Monetary Policy Committee (MPC) also noted that while high-frequency economic indicators pointed to a slow but steady recovery, real GDP growth had fallen short of expectations. Additionally, despite the current account posting a surplus in December 2024, foreign exchange reserves declined due to weak financial inflows and high external debt repayments. The committee also observed that tax revenues, despite showing an increase in December, were still below the set targets. Furthermore, recent volatility in global oil prices added an additional layer of uncertainty. Taking all these factors into account, the committee deemed it necessary to maintain a cautious stance on monetary policy to ensure long-term price stability.

Meanwhile, in a related development, the government reduced cut-off yields on treasury bills (T-bills) in its latest auction, signaling the possibility of further interest rate adjustments. The rates on T-bills dropped by up to 41 basis points, with the 12-month tenor declining to 11.38%—a cumulative decrease of 90 basis points since the auction on January 8. With yet another 100bps reduction in the policy rate, the central bank now faces a critical decision—should it continue its monetary easing cycle or pause to safeguard the fragile economic stability it has recently achieved?

Although the central bank has long refrained from offering forward guidance on interest rates, its latest monetary policy statement and the governor’s remarks provide valuable insights into its current approach. On one hand, the SBP emphasizes the need for a “cautious monetary policy stance” to maintain price stability and support sustainable economic growth. This means ensuring that the real policy rate stays sufficiently positive on a forward-looking basis to keep inflation within the 5-7% target range. At the same time, several inflationary risks remain on the horizon. Fluctuating global commodity prices, rising protectionism in major economies, adjustments in energy tariffs, unstable food prices, and potential new tax measures to meet revenue targets all signal the need for restraint in further rate cuts. These factors suggest that a pause—or at least a more measured approach to monetary easing—may be necessary.

However, the broader economic outlook presents a different picture. The current account is projected to show a 0.5% surplus relative to GDP, bolstered by higher remittances and a modest uptick in exports, despite significant debt repayments. Additionally, the SBP has revised its inflation forecast downward, now expecting average annual inflation to fall between 5.5% and 7.5%, much closer to its target range compared to the previous estimate of 11.5%–13.5% for the fiscal year. With real interest rates still standing at 790 basis points—well above the historical norm of 200-300 basis points—the central bank appears to have room to continue easing monetary policy if needed.

The recent months have shown signs of economic stabilization, and the temptation to push for faster growth is understandable. However, should the SBP risk repeating past mistakes? Despite improvements, the economy remains fragile. The steep 45.5% reduction in interest rates over the last seven months should be enough, for now, to signal confidence to businesses and investors. Rather than prioritizing rapid growth fueled by consumption-driven imports, the focus should be on long-term stability. History has shown that ignoring this lesson leads to crises—Pakistan has faced severe balance-of-payments challenges as recently as 2018 and 2022 due to hasty policy shifts driven by impatience with economic stabilization efforts.

Pursuing growth without implementing critical structural reforms, especially in an unpredictable global environment, could prove disastrous. The looming threat of a global trade war—intensified by US President Donald Trump’s aggressive tariff policies—only adds to the uncertainty. As always, the wealthiest segments of society would find ways to shield themselves from the consequences, while middle-class households, already bearing the burden of economic instability, would suffer the most. Now is the time for prudence, not reckless expansion.

Although recent policy measures have contributed to economic recovery, the SBP must tread carefully. The sharp reduction in interest rates has already signaled confidence to businesses and investors. Rather than prioritizing rapid growth at the risk of instability, a more measured approach focused on long-term sustainability is essential. Reckless expansion without structural reforms could lead to economic crises, disproportionately affecting middle-class households. Now is the time for prudence over short-term gains.