AFTER reducing the policy rate to 11 per cent in May 2025, the State Bank of Pakistan’s Mone­tary Policy Committee (MPC) has since kept the rate unchanged in its meetings on June 16 and July 30.

This decision appears imprudent, especially amid low inflation — 3.2 per cent in June and 4.1pc in July — and sub-optimal growth. The monetary policy statement issued on July 30 noted that year-on-year inflation is expected to remain largely within the 5-7pc target range in FY26. The MPC noted positive key developments since its last meeting. First, the SBP’s FX reserves crossed $14 billion on the back of improved financial inflows and a current account surplus. Second, the recent upgrade in Pakistan’s sovereign credit rating led to a decline in Eurobond yields and narrowed CDS (credit default swaps) spreads in international markets. It also acknowledged the government’s fiscal consolidation efforts, which resulted in a primary surplus in FY25 and an expected surplus of 2.4pc of GDP in FY26.

While the SBP notes positive trends in the economy and broadly sees things in the targeted or sustainable ranges, it has kept the policy rate unchanged amid sluggish economic activity. With inflation projected to remain within target, fiscal discipline in place, stable exchange rate despite heavy buying by the central bank to augment reserves, and the projected current account deficit to stay between 0-1pc of GDP in FY26, maintaining the policy rate at 11pc is difficult to justify — particularly when growth remains well below potential. In FY25, both large-scale manufacturing and agriculture posted negative growth.

Looking ahead, the floods make it unlikely that the already modest projected growth of 3.5pc in FY26 will be achieved. Headline inflation eased unexpectedly to 3pc in August 2025. In the aftermath of the floods, price spikes in perishable food items are likely, while demand-side inflation pressures are expected to be relatively contained.

Monetary policy must navigate a world shaped by a multiplicity of shocks.

Pakistan is caught in a low-growth, low-investment trap, and the SBP’s monetary stance is doing little to change that. By keeping the policy rate and exchange rate artificially high, the central bank is effectively stifling economic activity. High financing and production costs — driven by elevated interest rates and energy prices — are eroding business competitiveness, discouraging investment and undermining growth.

Under the SBP Act, the bank’s primary mandate is to maintain price stability. Monetary policy must be data-driven, and the policy rate should be set based on forward-looking inflation projections. When the MPC itself acknowledges that inflation has declined and is expected to stay within the target band, holding the policy rate at 11pc is unjustifiable.

Over the past decade, the SBP has adopted a more robust monetary policy framework aligned with inflation targeting. It has benefited from governance reforms, a clearer mandate, greater operational independence, both de jure and de facto, and improved transparency and accountability. The statutory MPC, established in 2015 to shield the central bank from political interference, now operates without any government representation. Yet, despite its independence from do­­­mestic political pressures, the MPC appears overly influenc­ed by the IMF, whose advice often leans towards excessive contraction, even when inflation is falling and real sector performance is deteriorating.

The SBP should aim to maintain a reasonably positive real interest rate — not an excessively positive one that strangles growth. Stabilisation without economic growth is becoming Pakistan’s new normal — an unsustainable path that only deepens unemployment, inequality and low human development. As the apex decision-making body, the MPC must broaden its perspective and consider the wider impact of its decisions on all segments of the economy, not just exporters, importers or the financial sector.

Now, let’s look at how global developments mig­ht impact our monetary policy. The global impact of ongoing tariff wars adds nuance to inflation dy­­namics. For countries facing higher tariffs on their exports, the result is typically a negative demand shock, exerting mild downward pressure on inflation. In contrast, for countries imposing much hi­­gher tariffs, notably the US, the tariffs will likely act more as an adverse supply shock, boosting inf­lation while lowering growth. So, Pak­­istan could potentially expect a better inflation outlook.

Moreover, in a more turbulent external environment, foreign exchange intervention can help address disorderly market conditions that undermine financial stability. This can improve macroeconomic outcomes as well as lower financial stability risks. However, it is important that FX intervention is not used to reduce exchange rate volatility per se, or to target a particular level of the exchange rate.

Lastly, there is a high premium on further stre­ngthening policy frameworks to continue building resilience in a more shock-prone environment.

Clarity of communication has become more critical than ever. Effective communication about the central bank’s reaction function — in qualitative terms — is likely to be useful in helping better anchor inflation expectations and thus improve trade-offs.

Improved governance can increase public confidence that the central bank will have latitude to achieve its objectives. Central banks will make mistakes — no forecast is perfect. But what must be clear is that any deviation from target is the result of uncertainty, not political interference.

The SBP must adapt its policy strategies to focus more on the distribution of outcomes than the model outlook, and to take more account of risk management considerations. Monetary policy must navigate a world shaped by a multiplicity of shocks — some persistent, some temporary, and some with offsetting effects on inflation where it is difficult to assess the net impact. The SBP should continue taking steps to revise its fra­meworks to move away from excessive reliance on central forecasts. This can be facilitated by increasing the use of scenario analysis in decision-making.

Monetary policy must remain data dependent. As the global economic order is reset and uncertainty prevails, the SBP should avoid unwarra­nted gradualism. If inflation pressures decline, it must respond quickly using policy instruments to tackle economic stagnation and unemployment. The road ahead may have many unforeseen turns, which calls for further strengthening fina­ncial and fiscal resilience and navigating with monetary policy clarity, credibility and discipline.

The writer is the author of The Shady Economics of International Aid. He has served as a senior adviser to the IMF, and chief economist and member of MPC at the State Bank of Pakistan.dr.saeedahmed1@hotmail.com

Published in Dawn, September 3rd, 2025