Pakistan’s monetary policy has entered a new easing phase as the State Bank of Pakistan (SBP) reduced the policy rate by 50 basis points (bps), effective December 16, 2025. This marks the second rate cut in 2025, following a 100 bps reduction in May 2025, when the policy rate was brought down from 12 percent to 11 percent. Notably, the policy rate had remained unchanged for seven months after May, signaling a cautious and data-driven approach by the Monetary Policy Committee (MPC).
The latest decision reflects growing confidence in Pakistan’s macroeconomic stabilization, improving inflation dynamics, and strengthening foreign exchange buffers, while also acknowledging persistent global and domestic risks.
Why the State Bank of Pakistan Cut the Policy Rate
According to the Monetary Policy Committee’s December 2025 statement, the decision to lower the policy rate by 0.5 percent was driven by a combination of stable inflation, improving economic activity, and anchored inflation expectations.
Inflation Within Target, but Core Pressures Persist
Inflation averaged within the SBP’s medium-term target range of 5–7 percent during July–November FY26. This stability was supported by:
- Relatively benign global commodity prices
- A prudent monetary policy stance
- Improved coordination with fiscal policy
However, the MPC acknowledged that core inflation remains sticky, requiring continued vigilance. Despite this, the overall inflation outlook remains broadly unchanged, giving policymakers enough space to cautiously support growth.
Economic Activity Gains Momentum
The MPC highlighted that Pakistan’s economy is showing clear signs of recovery, backed by strong high-frequency indicators.
Industrial Growth and Large-Scale Manufacturing
- Large-Scale Manufacturing (LSM) recorded 4.1 percent year-on-year growth in Q1-FY26
- Most industrial sub-sectors posted higher output
- Increased sales of automobiles, cement, and fertilizer
- Higher imports of machinery and intermediate goods, indicating expanding industrial capacity
These trends suggest that lower interest rates could further stimulate private investment and industrial expansion.
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Agriculture and Services Outlook
The agriculture sector also delivered positive signals:
- Wheat acreage, favorable input conditions, and government-backed incentives point to wheat production exceeding targets
- Strong performance in commodity-producing sectors is expected to support services sector growth
As a result, the SBP expects real GDP growth in FY26 to remain in the upper half of the projected 3.25–4.25 percent range, reinforcing optimism about Pakistan’s near-term economic trajectory.
External Sector: Reserves Strengthen Despite Export Pressures
Pakistan’s external sector remains one of the most closely watched areas of the economy.
Current Account and Trade Dynamics
- The current account deficit stood at $0.7 billion during July–October FY26, in line with expectations
- Imports increased alongside economic recovery
- Workers’ remittances remained resilient
- Exports faced pressure, mainly due to a sharp decline in food exports, particularly rice
Foreign Exchange Reserves and IMF Support
Despite weak export performance and modest financial inflows:
- SBP’s foreign exchange reserves rose above $15.8 billion
- This increase was supported by $1.2 billion from the IMF after successful completion of the EFF and RSF reviews
- Reserves have already exceeded the December 2025 target of $15.5 billion
Looking ahead, reserves are projected to reach $17.8 billion by June 2026, provided planned official inflows materialize. Lower global oil prices may help contain import growth, even as global trade uncertainties continue to weigh on exports.
Fiscal Performance: Early Gains, Long-Term Challenges
Pakistan’s fiscal position showed notable improvement in Q1-FY26:
- Both overall and primary balances recorded surpluses
- Strong performance was largely driven by a sizeable SBP profit transfer
- The expenditure-to-GDP ratio declined compared to last year
However, challenges remain:
- FBR tax collection growth slowed to 10.2 percent during July–November FY26
- Achieving annual tax targets will require significant acceleration
- While interest payments may remain lower than budgeted, achieving the targeted primary surplus remains difficult
The MPC strongly emphasized the need for structural reforms, particularly:
- Broadening the tax base
- Privatization or restructuring of loss-making state-owned enterprises (SOEs)
These reforms are critical to creating fiscal space for public investment and socioeconomic development.
Money, Credit, and Consumer Confidence
Easing financial conditions are beginning to reflect across the banking and credit landscape.
- Broad money (M2) growth accelerated to 14.9 percent by late November
- Private sector credit expanded by Rs187 billion during July–November FY26
- Key borrowing sectors included textiles, wholesale & retail, and chemicals
- Consumer financing, especially auto loans, remained strong due to improved sentiment and macroeconomic stability
Although year-on-year private sector credit growth remained slightly negative due to base effects, underlying momentum suggests that lower interest rates could further boost borrowing and investment.
Inflation Outlook and Risks Ahead
While headline inflation remains under control, the MPC cautioned that:
- Inflation may temporarily rise above the target range toward the end of FY26
- This would largely be due to low base effects
- Inflation is expected to return to the target range in FY27
Key risks include:
- Volatility in global commodity prices
- Energy price adjustments
- Fiscal slippages
- Uncertainty around wheat and perishable food prices
What the Rate Cut Means for Businesses and Investors
The 50 bps policy rate cut sends a strong signal that Pakistan’s central bank is shifting from stabilization to measured growth support, without compromising price stability. For businesses, this could mean:
- Lower borrowing costs
- Improved cash flows
- Stronger investment sentiment
For investors, the decision reinforces confidence in Pakistan’s macroeconomic management, especially amid improving reserves, fiscal discipline, and IMF program continuity.
Bottom Line
After holding rates steady for seven months, the State Bank of Pakistan has taken a calculated step toward monetary easing. With inflation largely under control, foreign exchange reserves strengthening, and economic activity gaining traction, the latest policy rate cut reflects cautious optimism about Pakistan’s economic outlook.
However, sustaining this momentum will depend on continued fiscal discipline, structural reforms, export recovery, and careful management of inflation risks. The MPC’s message is clear: monetary easing will support growth but long-term stability hinges on reform and coordination across the economy.
