SBP holds policy rate at 10.5pc as growth outlook improves, inflation seen within target

KARACHI: Defying market expectations of a rate cut, the State Bank of Pakistan (SBP) on Monday kept the policy rate unchanged at 10.5 per cent, citing steady inflation, improving economic activity, and a broadly stable external outlook.

The decision was taken at a meeting of the Monetary Policy Committee (MPC), which noted that headline inflation eased to 5.6 per cent year-on-year in December 2025, broadly in line with projections. However, the Committee flagged that core inflation remains elevated at around 7.4 per cent, warranting a cautious policy stance.

Despite rising imports and a wider trade deficit, the MPC observed that strong workers’ remittances and benign global commodity prices have helped keep the current account deficit contained. At the same time, economic momentum has strengthened faster than anticipated, driven largely by domestic-oriented sectors.

Given this backdrop, the MPC said holding rates steady was necessary to ensure price stability while supporting sustainable economic growth.

ECONOMIC ACTIVITY GAINS MOMENTUM

The MPC highlighted a notable pickup in economic activity, with real GDP growth provisionally recorded at 3.7 per cent in Q1-FY26, up sharply from 1.6 per cent in the same period last year. Growth was led by the industrial and agricultural sectors, while high-frequency indicators suggest the momentum has carried into the second quarter.

Large-scale manufacturing (LSM) posted strong gains, growing 8.0 per cent in October and 10.4 per cent in November, lifting cumulative growth to 6.0 per cent during July–November FY26. Auto sales, cement dispatches, fertilizer off-take, and machinery imports also showed robust expansion, signaling resilient domestic demand.

Reflecting these trends, the SBP upgraded its GDP growth forecast for FY26 to 3.75–4.75 per cent, with further strengthening expected in FY27.

EXTERNAL SECTOR AND FX RESERVES IMPROVE

Pakistan’s current account deficit stood at $244 million in December, taking the H1-FY26 deficit to $1.2 billion, mainly due to rising imports and weaker exports, particularly food exports such as rice.

However, sustained growth in workers’ remittances and ICT services exports helped cushion the impact. As a result, SBP’s foreign exchange reserves climbed to $16.1 billion by January 16, surpassing end-December targets through active interbank purchases.

The central bank expects the current account deficit to remain between 0–1 per cent of GDP in FY26, with FX reserves projected to exceed $18 billion by June 2026, barring external shocks.

FISCAL PRESSURES PERSIST

On the fiscal side, FBR tax revenues grew 9.5 per cent in H1-FY26, significantly slower than last year and below target, resulting in a Rs329 billion shortfall. While lower interest payments helped contain expenditures and improve the fiscal balance, the MPC cautioned that achieving the annual primary surplus target remains challenging.

The Committee stressed the importance of deepening fiscal reforms, including broadening the tax base and privatizing loss-making state-owned enterprises, to ensure durable macroeconomic stability.

INFLATION OUTLOOK AND CREDIT GROWTH

Inflation is projected to remain within the SBP’s 5-7 per cent target range over FY26 and FY27, though temporary pressures may emerge due to energy prices, wheat costs, and global commodity volatility.

Meanwhile, private sector credit picked up, expanding by Rs578 billion so far in FY26, supported by easing financial conditions. To further encourage lending, the SBP announced a reduction in the average Cash Reserve Requirement from 6 per cent to 5 per cent, a move expected to support business activity.