KARACHI:
Pakistan’s trajectory of steadily lowering interest rates has been disrupted by spillover effects of the Israel-US war on Iran, as the State Bank of Pakistan (SBP) on Monday raised its key policy rate by 100 basis points to 11.50%, citing inflation risks triggered by the geopolitical escalation and the resulting closure of the Straits, which expected a sharp market shutdown and market turn. criticism from the business community, who called it “beyond understanding” amid a still fragile economic recovery.
The Monetary Policy Committee (MPC) justified the rise at its latest meeting by pointing to rising global uncertainties stemming from the protracted Middle East conflict, which has pushed up energy prices, freight costs and insurance premiums, while disrupting supply chains. The central bank warned that these factors are likely to fuel inflationary pressures in the coming months, necessitating tighter monetary policy to anchor expectations and prevent second-round effects.
However, business leaders expressed concern that the decision could undermine investment and hamper private sector activity. The Pakistan Business Forum (PBF) said the increase was difficult to understand and questioned why authorities appeared to be moving away from the goal of making it easier to do business.
PBF President Khawaja Mehboobur Rehman said higher borrowing costs would further limit private sector credit uptake, making it more difficult for companies to expand their operations.
The SBP acknowledged that inflation had already started to pick up, with headline inflation rising to 7.3% in March, while core inflation edged up to 7.8%. It noted that inflation expectations among consumers and businesses had worsened in recent surveys, reinforcing the need for precautionary measures.
According to the central bank’s assessment, inflation is likely to accelerate further and could enter double-digit territory in the coming months, mainly driven by the impact of higher global energy prices. While food inflation remains relatively contained due to adequate supplies, rising fuel costs have already begun to spill over into transport prices and broader core inflation.
Despite these concerns, the MPC noted that the domestic economy has shown signs of resilience. Real GDP grew by 3.8% in the first half of FY26, supported by broad-based improvements across sectors. Major manufacturing grew strongly at 5.9% in July-February, while private sector credit continued to expand at around 13%, reflecting improved business activity and the lagged impact of earlier rate cuts.
Nevertheless, recent high-frequency indicators suggest some sluggishness in economic momentum, particularly in March, amid burgeoning external headwinds. The agricultural outlook is also somewhat muted due to lower-than-expected wheat production, which could weigh on overall growth.
On the external front, Pakistan recorded a small current account surplus during July-March FY26, supported primarily by resilient workers’ remittances. The government also managed to strengthen foreign exchange reserves through external financing, including the issuance of Eurobonds, which allowed the SBP’s reserves to remain around $15.8 billion at the end of April.
The central bank expects reserves to rise to over $18 billion in June ’26, underscoring the importance of continued efforts to build external buffers in an increasingly uncertain global environment. It also highlighted the recent staff-level agreement with the International Monetary Fund (IMF) as a positive development supporting macroeconomic stability.
On the fiscal front, challenges continue as tax collection by the Federal Board of Revenue (FBR) fell short of targets, widening the cumulative deficit to Rs611 billion during July-March. While the fiscal deficit has remained relatively contained so far, the SBP warned that rising global oil prices could complicate fiscal policy, particularly due to the need for targeted subsidies to protect vulnerable segments.
The MPC stressed that achieving the primary profit target for the full year is likely to require further expenditure rationalization along with structural reforms aimed at broadening the tax base and reducing losses from state-owned enterprises.
Going forward, the SBP maintained that maintaining macroeconomic stability would require a combination of prudent monetary policy, fiscal discipline and continued reform efforts. However, it also warned that the outlook remains highly uncertain and subject to risks related to the duration and intensity of the conflict in the Middle East, global commodity prices and potential fiscal slippage.
