Economic Advisory Group Acknowledges Proactive Monetary Policy; Urges Caution Amid Persistent Tailwinds

Islamabad, January 29, 2025 – The Economic Advisory Group (EAG) recognizes the proactive stance taken by the State Bank of Pakistan (SBP) in its latest Monetary Policy Statement (MPS). While the central bank has delivered a measured interest rate cut, the EAG emphasizes the need for caution as underlying inflationary pressures and external risks persist.

SBP is facing mounting pressure from various stakeholders to reduce interest rates. Given the complex economic landscape, the central bank must navigate these challenges prudently. The latest MPS reflects this careful balancing act, with SBP adopting a more measured tone by advocating for a “cautious monetary stance.”

The statement highlights key risks, including elevated and sticky core inflation, a volatile near-term inflation outlook, rising global oil prices, and increasing protectionism amid escalating trade tensions. These factors indicate that the Monetary Policy Committee (MPC) is taking a proactive approach, ensuring that expectations remain managed while signaling a potential slowdown—or even a pause—in further rate cuts.

While SBP appears to anticipate an improvement in economic growth, supported by leading indicators such as fertilizer offtake, petroleum sales, and rising import volumes, lagging indicators from Q1 GDP data suggest continued weakness in agriculture and large-scale manufacturing. Managing this economic momentum is crucial to preventing inflationary pressures from becoming more volatile.

Although the containment of broad money (M2) growth and an improved net financial asset position are positive developments, these gains may prove temporary without structural reforms. Rising import volumes and credit expansion—despite a yet-to-accelerate business cycle—raise concerns about future external vulnerabilities. Consolidating recent improvements in the current account remains critical, providing policymakers with some relief as they address inflationary challenges.

To sustain economic stability, it is imperative to strengthen export-import linkages, ensuring that imports drive productive activities and export growth. EAG firmly believes that long-term economic growth must be productivity driven, facilitated by free markets, good governance, and limited regulation. This can only be achieved by fostering an environment where domestic producers are forced to compete globally. Rather than imposing import restrictions, EAG advocates for the removal of trade barriers, including lowering tariffs and non-tariff barriers, to enhance competitiveness and productivity. Protectionist measures only serve to stifle innovation and efficiency, while a more open trade regime enables industries to integrate into global and regional value chains, driving sustainable economic expansion.

The M2 growth rate currently stands at 10%, exceeding SBP’s projected nominal GDP growth rate of 7-9%. Inflationary pressures may intensify before they fully materialize in monetary aggregates. Additionally, remittances have been rising due to various incentive schemes, but this trend could reverse if exchange rate volatility resurfaces. While the Real Effective Exchange Rate (REER) stands at 103.7, SBP anticipates exchange rate stability until the fiscal year-end. However, a strengthening US dollar is eroding Pakistan’s competitiveness relative to regional currencies, as SBP continues to resist depreciation pressures. SBP should use the cushion from rising remittances, which are projected to grow approximately by $5 billion in the current fiscal, to beef up reserves rather than exhaust it prematurely to finance economic growth.

On the external front, SBP remains confident that official multilateral inflows will meet net debt servicing requirements for the remainder of the fiscal year. The central bank projects year-end foreign exchange reserves at $13 billion—equivalent to approximately 2.5 months of import cover, a precarious level that underscores the urgency of boosting exports. Addressing the balance-of-payments crisis necessitates export expansion rather than import suppression, as restrictive import policies not only exacerbate inflation through supply shortages but also hinder industrial production by limiting access to essential raw materials and intermediate goods.

EAG reiterates the importance of a balanced monetary approach, aligning interest rate decisions with economic fundamentals while ensuring inflationary and external risks remain under control. The focus must remain on long-term economic resilience through structural reforms, increased industrial activity, and enhanced global competitiveness.

For further information, contact EAG Chair, Dr Aadil Nakhoda at anakhoda@iba.edu.pk