EVERY two months, the State Bank of Pakistan announces an interest rate. The announcement is treated as serious economic medicine. Hiking of the rate is presented as a fight against inflation and cuts as a spur to growth. Either way, the public narrative is the same: adults are managing the fragile economy with a sophisticated tool. What rarely gets mentioned is the trillions of rupees the SBP, quietly and regularly, pumps directly into the banking system with no public scrutiny or debate. On current ledger this funding is a staggering Rs16 trillion, while the press conference talks about need for continued tightening.

SBP raises interest rates to make money more expensive and slow down spending, because excessive spending drives up prices. That is the stated logic. But its actual operations contradict its stated policy as it pumps trillions into the system. More money circulating fuels spending, driving inflation higher.

This glaring contradiction requires understanding what that money is actually for. It is not going into productive investments and factories. It is financing the government’s deficits. Here is how the cycle works. The government spends more than it collects in taxes. To cover the gap, it borrows from banks. The injections exist because the banking system is the government’s primary lender, and it borrows so heavily that banks run dry. SBP then steps in and refills their coffers. The government stays funded. The banks stay liquid. And the illusion of financial stability is maintained.

When a government cannot control spending, it forces SBP to finance its spending, regardless of what the central bank says its policy is. The interest rate becomes a meaningless number on a press release. SBP’s unwritten policy appears to be simple: keep the government funded, whatever the cost. Furthermore, changes in interest rates are supposed to change behaviour. SBP’s continuous lending to the banks generates substantial profits for it, which flow back to the government as non-tax revenue. This circular loop results in the net cost of borrowing for the government being virtually zero — less than 0.5 per cent. At a price that doesn’t inflict pain why would anyone’s behaviour change?

Is the State Bank fighting inflation or financing government?

Industrialists and chambers of commerce continuously lobby for lower interest rates. They are wrong, but not for the reasons they think. If SBP were to stop injecting money into the banking system, the interest rate would not fall but rise. Banks would have to compete fiercely for whatever money exists in the market. And the interest rate, the price of money, would be bid up to levels higher than what SBP has announced. The rate we see is already an artificially suppressed number. The IMF, supposedly the guardian of sound monetary policy, looks the other way, while trillions are injected to defend the interest rate just announced.

The lobby demanding cheaper credit is, without knowing it, already receiving a subsidy. The market-clearing rate would be higher than the announced policy rate, not lower. The debate for rate cuts rests on a misunderstanding of how the current rate is being manufactured.

This brings us to another belief that policymakers and commentators here routinely get wrong: the idea that Pakistan’s inflation is caused by supply shocks, energy prices or global commodity markets which are forces beyond SBP’s control. Hence, the monetary policy cannot be blamed. This narrative is convenient — and wrong. Supply shocks can cause a one-time spike in prices, but cannot sustain inflation (a compounding increase in prices) month after month. Sustained inflation requires fuel which SBP provides by creating money, the trillions it injects into the financial system.

The bank officially claims to operate under a framework of ‘inflation targeting’. It sets an inflation target range (currently between 5pc and 7pc) and uses interest rates as its principal instrument to hit it. But monetary policy only works when governments live within their means. To be fair, there are other complications also at play that dilute the effectiveness of an interest rate increase — the unpredictability of government taxation, ad hoc increases in administered prices of energy, petroleum products, etc, and its regulatory distortion. These influences shape inflationary expectations of economic actors, which feeds into prices. Then there are factors: donor inflows, the informal economy reflected in the Rs12tr cash in circulation, SBP-sponsored concession export schemes and Rs14tr of remittances. All combine to create demand for goods and services that is largely impervious to interest rates.

However, they are not the primary driver. The biggest culprit, by a considerable distance, is the government and its insatiable appetite for spending that it cannot finance through taxation: total government borrowings for budgetary support today are Rs36tr — the equivalence of 120pc of bank deposits. Furthermore, a closer look at SBP interventions reveals that the real anchor is not inflation, but the exchange rate. When Pakistan is under an IMF programme, the rupee is kept relatively stable. When the programme ends and the rupee slides, inflation follows immediately. This sequence tells you something important. If it is the exchange rate actually driving prices, then the interest rate is just a prop in a performance.

The honest conversation is straightforward. Either the government controls its spending addiction so that SBP can genuinely pursue an inflation target, or admit that inflation targeting is theatre. Presently, we suffer the worst of both worlds: the rhetoric of a disciplined SBP masking the grim reality of a monetary system that quietly funds whatever the government cannot afford. The real question is whether anyone in authority has the courage to say it plainly.

The interest rate is not actually a tool of inflation control, but a number announced while the real business of money creation happens elsewhere, out of sight and largely out of public conversation. Therefore, the next time industrialists demand cheaper credit they should be asked: cheaper than what? The rate is already a fiction. The unsubsidised truth would cost considerably more.

Nadeem ul Haque is former VC PIDE and deputy chair of the Planning Commission. Shahid Kardar is a former governor of the State Bank of Pakistan.

Published in Dawn, July 5th, 2026