The State Bank of Pakistan’s Monetary Policy Committee has raised the policy rate by 100 basis points to 11.5 percent, a move that broadly matched market expectations though forecasts had ranged widely from 50 to 200 basis points. The decision reflects a balancing act between inflation management, external uncertainties, and the broader demands of Pakistan’s economic stabilization programme.
The divergence in market expectations was rooted in two important factors. First, analysts have long observed that monetary policy in Pakistan often operates within the broader framework of the country’s engagement with the International Monetary Fund. Under an ongoing Fund programme, domestic projections become more difficult because policy choices are shaped not only by local economic conditions but also by the expectations of international lenders.
The IMF traditionally places considerable emphasis on conventional monetary policy theory, where higher interest rates are viewed as a tool to contain inflation by reducing demand and moderating credit expansion. Pakistani economists, however, often argue that the domestic transmission mechanism is different. In Pakistan’s case, policy rate changes affect the economy most directly through government borrowing costs rather than through private-sector credit.
This distinction is crucial. In the current fiscal year, around Rs8 trillion has been allocated for debt servicing and mark-up payments. By comparison, defence spending stands at about Rs2.5 trillion, while grants and transfers—including the Benazir Income Support Programme—are close to Rs2 trillion. This makes debt servicing the single largest component of current expenditure. A rise in the policy rate therefore has immediate fiscal implications, increasing the government’s financing burden and narrowing fiscal space.
Private-sector borrowing, by contrast, remains relatively limited. According to the finance ministry, total credit to the private sector during July–March 2026 amounted to Rs887.5 billion. This remains modest when compared with state-linked borrowing. In fact, the power sector alone borrowed about Rs1.25 trillion during the same period to address the country’s persistent circular debt problem.
The limited scale of private-sector credit reflects the difficult environment facing businesses. Major industries, particularly textiles and cement, have repeatedly cited high input costs, elevated borrowing rates, and tight fiscal and monetary conditions as key reasons behind the closure of more than 150 industrial units. For manufacturers already operating under pressure, higher interest rates risk further constraining investment and production.
The latest monetary decision must also be viewed in the context of recent developments under Pakistan’s IMF programme. On March 27, the IMF announced that a staff-level agreement had been reached on the third review of the ongoing programme. In its statement, the Fund noted that inflation and the current account had remained contained, while external buffers had continued to improve. At the same time, it cautioned that tensions in the Middle East posed significant risks through volatile energy prices, tighter global financial conditions, and potential pressures on inflation, growth, and the balance of payments.
Against this backdrop, the 100-basis-point increase appears to represent a compromise between domestic authorities, who are concerned about the impact of higher rates on growth, and the IMF, which remains focused on inflation management and external stability. The decision also leaves room for further adjustments at the next MPC meeting, particularly if geopolitical uncertainties intensify.
A second factor shaping market perceptions relates to the inflation indicators used by policymakers. During the tenure of former Reza Baqir, the MPC relied heavily on the Consumer Price Index as the principal benchmark for setting interest rates. Earlier practice had placed greater emphasis on core inflation, which excludes volatile food and energy prices. Recent data suggests that core inflation may once again be gaining importance. In March 2026, headline inflation rose to 7.3 percent from 7 percent in February. Yet a comparable increase in 2024—from 6.9 percent in September to 7.2 percent in October—was followed by a sharp 250-basis-point cut in the policy rate, reducing it from 17.5 percent to 15 percent.
Core inflation tells a somewhat different story. It stood at 7.4 percent in March 2026, broadly similar to the level recorded in April 2025, when the MPC had reduced the policy rate by 100 basis points to 11 percent. This suggests that policymakers may now be giving greater weight to underlying inflation trends rather than short-term fluctuations in headline prices.
The latest Monetary Policy Statement also contained an important fiscal message. It noted that achieving the targeted full-year primary surplus may require deeper expenditure cuts. The committee further stressed the importance of sustained fiscal reforms, including widening the tax base and reducing losses in state-owned enterprises.
This marks a notable shift in tone. Earlier policy statements generally avoided explicit references to expenditure reductions, possibly to avoid friction with politically influential stakeholders. Yet the challenge remains complex. In practice, expenditure cuts often fall disproportionately on development spending rather than current expenditure. Such reductions can weaken economic growth by slowing infrastructure investment and public sector development projects.
The statement also highlighted improvements in external financing. The government has raised additional funds through enhanced bilateral arrangements and **Eurobonds**, which helped cushion the impact of recent debt repayments on foreign exchange reserves. As a result, the central bank expects its foreign exchange reserves to rise above $18 billion by June 2026.
Nevertheless, external vulnerabilities remain a source of concern. The IMF’s third review again underlined that exchange rate flexibility should remain the primary shock absorber, particularly in the event of spillovers from regional geopolitical tensions. At the same time, the Fund stressed the need for the banking system to remain capable of facilitating import financing and other external payments under potentially elevated balance-of-payments pressures.
This issue could become a point of debate between the IMF and the SBP. The exchange rate has remained unusually stable in recent months, fluctuating within a narrow band of Rs278 to Rs280 against the US dollar. While this stability has provided short-term confidence, some domestic and international market participants have expressed concern that the rupee may be stronger than underlying economic fundamentals justify.
In conclusion, the latest rate increase reflects the difficult trade-offs facing Pakistan’s economic managers. Inflation risks, external uncertainties, fiscal pressures, and IMF programme commitments are all shaping monetary policy choices. The 100-basis-point hike signals caution rather than aggressive tightening. Yet the broader challenge remains unchanged: without credible fiscal reforms, stronger external buffers, and a clearer growth strategy, monetary policy alone will have limited ability to stabilize the economy or restore durable confidence.