Policy rate slashed to 11%

Beating the market expectations of a 50 basis points (bps) cut, the State Bank of Pakistan (SBP) has slashed the policy rate by 100 bps to 11%, effective May 6, 2025, reflecting easing inflationary pressures. However, the central bank has highlighted that the broader economic landscape remains fraught with challenges, including sluggish GDP growth, weak large-scale manufacturing, persistent fiscal slippages, and external sector vulnerabilities.

Governor SBP, in a press conference along with other Monetary Policy Committee (MPC) members, announced a 100 bps cut, highlighting an improved1 inflation outlook and signs of moderate economic recovery. Beating the market expectations of 0-50bps cut, the central bank has reduced the policy rate by 100bps to 11% in a meeting held today," wrote Topline Securities. "We expect interest rates to come down to 10% by Dec 2025."

Arif Habib Limited had issued a survey result on 28th Feb 2025 saying that they expect the SBP to cut the policy rate by 50 bps to 11.5% in the upcoming monetary policy, citing that a clear majority of respondents, 54.6%, expect the SBP to ease monetary policy. Of those, 36.4% predict a 100bps reduction, while 18.2% foresee a 50bps cut. On the other hand, 45.4% believe the policy rate will remain at 12.0%.

This more-than-expected cut depicts an improved picture of the economy. However, Pakistan's economic growth remains fragile, with real GDP increasing by only 1.7% in Q2-FY25 and 1.5% in the first half of the fiscal year, according to the MPC. Large-scale manufacturing (LSM) continues to underperform, particularly in construction-allied sectors, which offsets gains in textiles, pharmaceuticals, and autos. In the agriculture sector, wheat production, although meeting targets, was lower than last year, highlighting ongoing vulnerabilities. The overall growth outlook for FY25 remains modest at 2.5–3.5%, and is highly susceptible to downside risks stemming from the global economic slowdown, as reflected in the IMF's downgraded projections for 2025–26, and potentially adverse weather conditions affecting the upcoming Kharif season.

Inflation, monetary policy uncertainty

Headline inflation dropped sharply to 0.3% year-on-year in April 2025, driven by declining food and energy prices. However, several risks cloud the inflation outlook, including potential volatility in wheat and other staple food prices, uncertain adjustments in trade tariffs, and global supply chain disruptions impacting commodity prices. In response to easing inflation, the SBP cut the policy rate by 100 basis points to 11%. Despite this monetary easing, external uncertainties—such as trade tariffs and geopolitical tensions—pose a threat to the current disinflationary trend.

External sector vulnerabilities

Although the current account posted a $1.9 billion surplus during July–March FY25, primarily due to record-high remittances and lower oil import costs, this was partially offset by a sharp rise in the trade deficit in April, which reached $3.4 billion. Financial inflows remain weak due to heavy external debt repayments and delays in official disbursements, keeping foreign exchange reserves under pressure. Although the SBP anticipates reserves to reach $14 billion by June 2025, the outlook remains uncertain and heavily dependent on the realisation of inflows and stability in global trade and commodity markets.

Fiscal sector challenges

Despite a year-on-year growth of 26.3% in FBR tax revenues during July–April FY25, collections continue to fall short of targets. MPC noted that achieving the primary fiscal surplus remains difficult amid expenditure pressures. The fiscal outlook demands urgent structural reforms, particularly in expanding the tax base, most notably through the enforcement of agricultural income taxation, and restructuring loss-making state-owned enterprises (SOEs) to reduce their burden on public finances.

Financial sector risks

Private sector credit grew by 12.6% year-on-year, reflecting improved economic activity, yet borrowing remains concentrated in a few sectors such as textiles, automobiles, and personal finance. Moreover, Eid-related currency withdrawals led to a temporary spike in currency circulation, driving reserve money in circulation growth to 13.1% by mid-April. These trends highlight underlying liquidity pressures and potential inflationary risks if credit expansion becomes misaligned with real sector performance.

Pakistan's economic outlook remains exposed to a range of domestic and external risks, including heightened global uncertainty (trade wars, geopolitical instability, and oil price fluctuations), domestic inflationary pressures from food and energy prices, continued underperformance in LSM and agriculture, fiscal slippages due to revenue shortfalls, and vulnerabilities in the external sector from widening trade deficits and heavy debt servicing. Addressing these challenges will require careful macroeconomic management and sustained structural reforms, MPC said.