KARACHI:

Pakistan’s trajectory of steadily lowering interest rates has been disrupted by spillover effects of Israel-US war on Iran, as the State Bank of Pakistan (SBP) on Monday raised key policy rate by 100 basis points to 11.50%, citing inflationary risks triggered by the geopolitical escalation and the resulting closure of the Strait of Hormuz, a move that defied market expectations and drew sharp criticism from the business community, which termed it “beyond understanding” amid a still-fragile economic recovery.

The Monetary Policy Committee (MPC), in its latest meeting, justified the increase by pointing to rising global uncertainties stemming from the prolonged Middle East conflict, which has pushed up energy prices, freight costs, and insurance premiums, while also disrupting supply chains. The central bank warned that these factors are likely to fuel inflationary pressures in the coming months, necessitating a tighter monetary stance to anchor expectations and prevent second-round effects.

However, business leaders expressed concern that the decision could undermine investment and hamper private sector activity. The Pakistan Business Forum (PBF) said the increase was difficult to comprehend, questioning why authorities appeared to be moving away from the goal of improving ease of doing business.

PBF President Khawaja Mehboobur Rehman said higher borrowing costs would further constrain private sector credit uptake, making it harder for businesses to expand operations.

The SBP acknowledged that inflation had already started to pick up, with headline inflation rising to 7.3% in March, while core inflation edged up to 7.8%. It noted that inflation expectations among consumers and businesses had deteriorated in recent surveys, reinforcing the need for preemptive action.

According to the central bank’s assessment, inflation is likely to accelerate further and could enter double-digit territory in the coming months, largely driven by the pass-through of higher global energy prices. While food inflation remains relatively contained due to adequate supplies, rising fuel costs have already begun to spill over into transport fares and broader core inflation.

Despite these concerns, the MPC noted that the domestic economy has shown signs of resilience. Real GDP grew by 3.8% in the first half of FY26, supported by broad-based improvements across sectors. Large-scale manufacturing posted a strong growth of 5.9% during July-February, while private sector credit continued to expand at around 13%, reflecting improving business activity and the lagged impact of earlier rate cuts.

Nonetheless, recent high-frequency indicators suggest some sluggishness in economic momentum, particularly in March, amid emerging external headwinds. Agricultural prospects have also damped slightly due to lower-than-expected wheat production, which could weigh on overall growth.

On the external front, Pakistan recorded a small current account surplus during July-March FY26, supported primarily by resilient workers’ remittances. The government also managed to shore up foreign exchange reserves through external financing, including the issuance of Eurobonds, allowing the SBP’s reserves to stay around $15.8 billion as of late April.

The central bank expects reserves to rise above $18 billion by June ’26, underscoring the importance of continued efforts to build external buffers in an increasingly uncertain global environment. It also highlighted the recent staff-level agreement with the International Monetary Fund (IMF) as a positive development supporting macroeconomic stability.

In the fiscal domain, challenges persist as tax collection by the Federal Board of Revenue (FBR) fell short of targets, widening the cumulative shortfall to Rs611 billion during July-March. While the fiscal deficit has remained relatively contained so far, the SBP warned that rising global oil prices could complicate fiscal management, particularly due to the need for targeted subsidies to protect vulnerable segments.

The MPC stressed that achieving the full-year primary surplus target would likely require further expenditure rationalisation, alongside structural reforms aimed at broadening the tax base and reducing losses from state-owned enterprises.

Looking ahead, the SBP maintained that sustaining macroeconomic stability would require a combination of prudent monetary policy, fiscal discipline, and continued reform efforts. However, it also cautioned that the outlook remains highly uncertain and subject to risks related to the duration and intensity of the Middle East conflict, global commodity prices, and potential fiscal slippages.