Economic Advisory Group (EAG) supports the cautious stance of the SBP in maintaining the policy rate at 12 percent.
Islamabad, March 12, 2025 – The Monetary Policy Committee (MPC) has decided to maintain the policy rate at 12 percent. This decision reflects a balancing act between declining headline inflation and persistent core inflation, alongside a gaining traction in economic activity and emerging pressures on the external account.
The headline inflation has fallen more than expected in February 2025, primarily due to lower food and energy prices. At the same time, inflation for many of the subcategories comprising the CPI basket remain in double digit. These include clothing and footwear, health, education, and miscellaneous. As a result, core inflation (inflation after excluding food and energy) continues to remain above the SBP’s target rate of 5 – 7%. The failure to bring core inflation within the target range is concerning as this is the period when exchange rate has remained stable and there have been no demand side pressures.
This persistence in core inflation poses a risk that a rebound in food and energy inflation could push overall inflation above the SBP target once again. The yields on long term government bonds also suggest that the market is pricing in an inflation rate of 7 to 9% over the medium to long term, instead of the 5 – 7% where the SBP wants inflation to be. The yields on PIBs have remained stable at around 12%. This is comparable with the yields on PIBs before the crisis started.
The EAG also appreciates the challenge that the SBP faces towards achieving its objectives. The year-on-year growth rate for large scale manufacturing (LSM) has remained negative throughout the first half of the ongoing fiscal year. The LSM index is still 12% lower relative to its pre-crisis peak. Lackluster performance together with the large drop in overall inflation may suggest that there is room for expansionary policies.
However, EAG advises policymakers to maintain a cautionary approach. There are two important reasons for this. First, as mentioned above, core inflation continues to stay above SBP’s target range. Moreover, SBP is still to convince the market that it will meet its inflation target over the medium to long run. Second, a further drop in policy rate can once again leave the economy vulnerable to a crisis on the external front. SBP’s data continues to show that foreign currency outflows over the next 12 months are expected to equal $30bn.
An improvement in business and consumer sentiment is also indicative that the economic activity may pick up in future. However, with this, it is likely that external pressures on the current account will resurface. The current account turned into a deficit of $0.4 billion in January 2025 after a period of surplus. This, coupled with weak financial inflows and ongoing debt repayments, has led to a decline in the State Bank of Pakistan’s (SBP) foreign exchange reserves. Although the increase in inflows through exports and remittances may provide some relief to policymakers, the uncertainty in the global financial markets due to inward looking and trade restrictive policies imposed by the more developed countries can create challenges on the external front. EAG agrees with SBP that it is imperative to strengthen external buffers as global economic conditions become more uncertain.
The EAG emphasises that it is critical to undertake meaningful structural reforms in order to achieve not only higher but more sustainable economic growth. Without this, it will be impossible to achieve higher economic growth that eludes the balance of payment crisis. In earlier works, the EAG laid out a framework which can guide policymakers in implementing reforms that can help transform the economy.
Industrial competitiveness, or the lack thereof, remains another core issue. Pakistan’s manufacturing sector is struggling due to high import tariffs and protectionist policies that favor inefficiency over genuine market competition. Lowering import tariffs, reducing barriers to entry, and encouraging export-oriented growth are essential to making domestic industries more competitive globally.
Shutting down redundant ministries rather than expanding the federal cabinet, selling off SOEs on the stock exchange if strategic buyers cannot be found, deregulating administered prices of fuel and electricity, unleashing the wholesale market of energy trading and wheeling, stopping the over-reliance on indirect taxes, and restoring horizontal equity in direct taxation—these are the necessary steps toward sustainable growth. Without them, Pakistan will remain trapped in a cycle of short-lived booms and inevitable busts, where monetary interventions serve only as temporary relief rather than a real cure.
Only productivity-enhancing reforms can induce sustainable and enduring economic growth without the traditional tradeoffs of monetary easing: debt-fueled growth with inflation risks lurking just around the corner.
For further information, contact EAG Chair, Dr Aadil Nakhoda at anakhoda@iba.edu.pk
The Economic Advisory Group is an independent platform of individuals drawn from economics, policy and the private sector. It was formed in January 2021, under the auspices of PRIME Institute, an independent think tank, which serves as its secretariat.
Chair: Aadil Nakhoda, IBA Karachi
Members:
Ahmed Jamal Pirzada, Bristol University
Ali Salman, PRIME Institute
Mueen Batlay, CERP
Muhammad Adil Mansoor, Business Recorder
Muhammad Ashraf Khan, Retired Federal Secretary
Najma Pirzada, The Life Sciences Division
Sajid Amin Javed, SDPI
Samir Ahmed, LUMS
Vaqar Ahmed, SDPI