Prudence, not panic: Reading the SBP’s 50bps policy rate hike

In the financial world, it’s very hard to label a decision as entirely correct or entirely wrong unless one decides to peg the currency against a dollar with very little reserves or in Former Minister of Finance Dr Abdul Hafeez Sheikh’s words “considering the currency a sign of manhood”.

This is what I feel while penning down my thoughts about yesterday’s, State Bank of Pakistan’s decision on Monday to raise the policy rate by 50 basis points to 12 percent, the highest in 17 months, belongs in that grey zone. It is neither a blunder nor a masterstroke. It is a judgement made under uncertainty, and the fair question is whether it was reasonable given what the committee could see, and what it could not.

By that standard, it was. Pakistan today is not the economy those words describe. The SBP holds around USD 21.5 billion in reserves, equal to three months of import cover, and a staff-level agreement with the IMF has been reached. The hike is less about defending a number than about keeping inflation expectations anchored while a global energy shock plays out.

A decision long telegraphed

Nine of the ten members of the Monetary Policy Committee voted for the increase, effective 27 October, and one reportedly favoured a larger move. It is the first rise since April, when the SBP raised rates by 100bps to 11.5 percent. At the previous meeting, seven members voted to hold and three wanted 100bps, so the direction was never really in doubt. The size was. A 50bps move sits between patience and aggressive tightening, and even Topline Securities survey found a majority of respondents expected an increase.

Inflation: The case for insurance

The inflation numbers explain the vote. Headline inflation reached 11.1 percent in August and eased to 10.3 percent in September, higher than the committee expected, while core inflation has steadied around 8.4 percent, well above the 5-7 percent target. Energy and wheat are the two main culprits, and the SBP expects both pressures to continue over the next few months.

At 12 percent, the policy rate sits only about 1.7 percentage points above September’s headline reading. That is a thin cushion. One reasonable projection, with oil settling near $100 a barrel, has inflation in a 9-11 percent range until March, before easing towards 7 percent in the final quarter on favourable base effects. On that path the real rate stays only modestly positive for months. A prolonged conflict would push inflation higher, while an end to hostilities could bring it down much faster.

The deeper worry is what comes next. The committee fears that expensive food and energy will seep into wage and price expectations and eventually into core inflation. Consumers’ inflation expectations rose in the latest survey, even as business expectations declined, and the Governor said the secondary impact is what the bank needs to be concerned about. A modest hike now is cheaper than a larger one later.

Growth is on recovery, but the path so far is a fragile one

The hike lands on an economy that is recovering gradually rather than booming. FY26 growth was revised to 3.7 percent, and the SBP still expects 3.5 to 4.5 percent in FY27. Large-scale manufacturing grew 1.9 percent in July-August, against 0.4 percent in the last quarter of FY26, while cement and petroleum sales, the PMI and private sector credit growth of 14.1 percent all point the same way. Early Kharif estimates were also better than anticipated.

The costs are real, though. Confidence indicators for both consumers and businesses weakened, and think tanks like PIDE argued that while risks had tilted towards tightening, conditions did not yet establish a compelling case for an immediate hike. The Governor countered that export stagnation no longer has any relationship with interest rates, pointing to concessional export refinancing at 4.5 percent. That is a fair point for exporters, but less convincing for the domestic investment the recovery needs. Add the risk of further escalation in the Middle East and worsening El Niño conditions, which the SBP itself flags as threats to growth, and 50bps looks tolerable. A string of larger hikes would not.

Fiscal: Discipline, with caveats

The fiscal numbers have been better than feared. FBR collections grew 7 percent in the first quarter and beat the target by Rs33 billion, and the overall and primary balances are assessed to be in surplus. But that surplus owes something to a substantial SBP profit transfer and contained expenditure, neither of which can be counted on indefinitely.

October is already looking harder, with the FBR likely to miss its monthly target. The SBP itself concedes that the conflict has made fiscal management more challenging, and it lists unanticipated energy tariff adjustments among its inflation risks. Higher rates will also feed into a government interest bill that is already the biggest item in the budget.

The good news is that we have buffers that did not exist before

It matters that these risks are being weighed from a position of relative strength. The current account deficit was USD 874 million in the first quarter of FY27, against USD 755 million a year earlier, a modest deterioration given the scale of the energy shock. The SBP expects the full-year deficit to stay within 0-1 percent of GDP, with remittances projected at USD 45 billion, exports at USD 32.5 billion and imports at USD 71 billion. Pakistan has regained access to international debt markets, reserves are at record levels, and improved credit ratings are easing rollover concerns. So far, an oil shock has not become a balance-of-payments crisis.

The soft spot is imports. Non-oil imports rose 15 percent in the first quarter, against 6 percent for petroleum, led by cars, machinery and other non-energy goods. Some of that reflects recovering investment and consumption, but a currency that has barely moved also makes imports relatively cheaper.

The PKR parity question!

This is the harder conversation. Pakistan’s real effective exchange rate has climbed to nearly 109, its highest in eight years, because domestic inflation runs above that of trading partners while the nominal rate barely moves. The index does not prove a precise misalignment, but its direction is difficult to ignore.

A modest, orderly depreciation would let the exchange rate absorb part of the shock and reduce the burden on interest rates. It would carry inflationary costs of its own when imported energy is expensive, but a frozen nominal rate is not costless either. The political appetite for it is limited. With rupee stability a centrepiece of the macroeconomic success story, interest rates are left to do more of the adjustment. As major central banks raise rates, the yield advantage on rupee assets narrows, and exchange rate expectations matter more.

Why 12% may not be the end

This is why the hike should come with a caution. The balance of risks is tilted upward, and the geopolitical picture is fluid. Oil has stayed above USD 100 a barrel, and Brent crossed USD 115 in the days before the meeting as markets braced for another US-Iran escalation and there’s also a FED meeting coming up with possible hikes in the benchmark rate too. Disruptions to trade with Iran have already caused shortages and sharp price increases in LPG. With winter approaching and LNG availability lower, shortages could follow, not just higher prices. Wheat supply frictions, adverse weather and a softening revenue picture are further moving parts.

The next meeting of SBP’s monetary policy committee is scheduled for 14 December. If oil stays elevated, inflation fails to ease as hoped, or global tightening continues, the committee may well need to act again. Further hikes cannot be ruled out. Equally, a durable end to hostilities and a reversal in energy prices would give the SBP room to pause. The central bank has little choice but to be data-dependent and prudent.

The larger question

The SBP’s choice is defensible. A case could be made for anything from holding to 100bps, and 50 acknowledges the risks without imposing the full cost of aggressive tightening. The harder question remains unanswered. Pakistan has shown it can absorb an oil shock without another balance-of-payments crisis. It has yet to show it can keep external stability without making the exchange rate a political commitment and interest rates the instrument used to defend it.

Pakistan’s reserves are no longer so thin that every decision becomes a verdict on survival, and that is real progress. The task now is to make sure stability is not confused with immobility, and that the currency is treated as a price rather than a point of pride.