Pakistan’s policy dilemma

LAHORE: The State Bank of Pakistan’s (SBP) decision to keep the policy rate unchanged -- after maintaining a record high of 22 per cent in June 2023 -- must be viewed in the context of the country’s broader macroeconomic challenges and the trade-offs faced by policymakers.

Whether this decision ‘makes sense’ depends on the objectives being prioritised: inflation control, external account stability or economic growth. Although headline inflation has eased, the SBP opted to maintain rates. However, interest rates alone cannot address all economic challenges. Under the IMF programme, central banks often face pressure to remain conservative to control inflation and build external buffers. The primary reason for holding rates was to maintain rupee stability; a premature rate cut could have triggered capital flight or further dollarisation.

Given ongoing fiscal slippages and the continuation of subsidy programmes, monetary tightening alone may prove insufficient. Since the SBP has limited influence over fiscal policy and government subsidies, it relied on the monetary policy as a precaution to avoid acting prematurely.

The decision carries both benefits and drawbacks for the business community. In the short term, high borrowing costs continue to suppress private investment, particularly in capital-intensive sectors. Working capital financing remains expensive—especially for SMEs and exporters facing delayed receivables. Key sectors such as real estate, automobiles, construction, and manufacturing remain subdued due to the high cost of credit.

Over the longer term, the impact is likely to be mixed. If the rate hold contributes to sustained disinflation and rupee stability, it could improve investor confidence. However, prolonged high rates without corresponding fiscal reforms may dampen industrial output and stall economic activity.

High interest rates do support the rupee by keeping returns on rupee-denominated assets attractive, discouraging speculative dollar demand, and attracting remittances and hot money into T-bills -- as seen in recent months. But if the real sector weakens under the weight of these rates and external financing needs rise, pressure on the currency could return. Interest rate-based rupee support is not sustainable without coordinated fiscal discipline. The responsibility now lies with the government to implement transparent reforms and restore fiscal stability.

The current policy stance also poses challenges for exporters. Elevated interest rates increase the cost of export financing, making Pakistani goods less competitive. Exporters, particularly in textiles and engineering, face margin compression, especially as regional peers such as Bangladesh and India continue to offer subsidised credit and energy.

That said, a stable rupee helps mitigate exchange rate losses for exporters, and falling inflation may stabilise input costs, partially offsetting the impact of higher financing costs. The SBP’s decision to maintain rates can be justified from a stabilisation standpoint -- particularly in light of the IMF’s cautious outlook and the need to contain inflation and currency volatility.

Nonetheless, this approach risks stifling the real economy and delaying recovery in business confidence, investment, and exports. A coordinated policy mix -- combining fiscal tightening, tax reform, and targeted export incentives -- is urgently required. Without this, high interest rates may worsen stagflation and undermine medium-term growth prospects.