Pakistan raises policy rate to 17-month high of 12%

The State Bank of Pakistan (SBP) on Monday raised its policy rate by 50 basis points to 12%, taking the benchmark interest rate to a 17-month high as escalating conflict in the Middle East and persistent energy price pressures worsened the inflation outlook.

The Monetary Policy Committee (MPC) approved the increase by a majority of nine out of 10 members, with the new rate taking effect from October 27, 2026.

In its monetary policy statement, the central bank said the intensification of the Middle East conflict and limited prospects for a near-term resolution had kept global energy prices persistently elevated. Domestic wheat supply issues have also contributed to inflationary pressures.

Although the impact of the global supply shock on Pakistan's economy has remained contained so far, the SBP said geopolitical developments had worsened the inflation outlook compared with its previous assessment.

The central bank said the rate increase was necessary to anchor inflation expectations, prevent higher energy and food prices from triggering broader price increases, and bring inflation within its target range of 5% to 7%.

Inflation outlook worsens

Pakistan's headline inflation rose to 10.3% year-on-year in September, exceeding the MPC's expectations. Higher energy prices and wheat and related product costs contributed significantly to the increase.

Core inflation also remained elevated at around 8.4%, indicating that price pressures extend beyond volatile food and energy components.

The SBP warned that persistently high food and energy inflation could push up inflation expectations and eventually feed into core inflation. Other risks include geopolitical tensions, global commodity price volatility, unexpected energy tariff adjustments, further increases in wheat prices and adverse weather conditions.

The committee said maintaining an adequately positive real policy rate on a forward-looking basis was important to bring inflation back within the target range over the medium term.

GDP growth forecast unchanged

Despite the increase in interest rates, the SBP maintained its economic growth forecast for FY27 at 3.5% to 4.5%, citing a gradual recovery in economic activity.

Large-scale manufacturing output grew 1.9% year-on-year during July and August FY27, compared with marginal growth of 0.4% in the fourth quarter of FY26.

Other indicators, including cement and petroleum, oil and lubricants (POL) sales, private sector credit and the Purchasing Managers Index, also pointed to improving activity.

The central bank said initial estimates for Kharif crops were better than anticipated, improving the outlook for agriculture. Indicators for the services sector, including information and communication technology exports and import volumes, also suggested gradually improving prospects.

However, the growth outlook remains vulnerable to a further escalation of the Middle East conflict and adverse climate events amid worsening El Niño conditions.

Current account deficit reaches USD 874 million

Pakistan recorded a current account deficit of USD 874 million during the first quarter of FY27. The SBP expects the deficit for the full fiscal year to remain within its earlier projected range of 0% to 1% of gross domestic product (GDP).

Exports have been recovering, supported by rice, high-value-added textiles and services, while workers' remittances have remained resilient and are projected to exceed earlier expectations.

However, imports have also risen sharply, led by non-energy goods as economic activity recovers and prices increase.

The SBP said the projected current account position, combined with higher financial inflows, could lift its foreign exchange reserves above their current level.

Reserves remained stable at around USD 21.5 billion, equivalent to approximately three months of import cover, supported by continued foreign exchange purchases.

The central bank warned that elevated global commodity prices, tighter international financial conditions and supply constraints continued to pose risks to the external sector.

Fiscal position remains in surplus

The Federal Board of Revenue's tax collection grew 7% year-on-year during Q1FY27, exceeding its target by PKR 33 billion.

The SBP assessed that Pakistan's overall fiscal and primary balances remained in surplus during the quarter, supported by a substantial transfer of central bank profits and contained government expenditure.

However, the central bank cautioned that the intensification of the Middle East conflict had made fiscal management more challenging.

It stressed the need to strengthen fiscal discipline, broaden the tax base, improve revenue mobilisation and accelerate structural reforms to sustain macroeconomic stability.

The MPC also highlighted the importance of maintaining a prudent mix of monetary and fiscal policies while building stronger external and fiscal buffers against future shocks.

Private sector borrowing continues to grow

Broad money supply growth increased to 12.7% year-on-year as of October 9, up from 11.4% on August 28, largely reflecting faster growth in net foreign assets following an increase in the SBP's foreign exchange reserves.

Growth in net domestic assets slowed amid fiscal consolidation and higher external financing, reducing the government's net borrowing from the banking system.

This created room for greater lending to businesses and consumers. Private sector credit grew 14.1% year-on-year, with borrowing expanding across working capital, fixed investment and consumer financing.

Textiles, wholesale and retail trade, and agriculture were among the major borrowing sectors.

The SBP expects private sector credit to maintain its momentum alongside the projected recovery in economic activity.

The committee also noted that major central banks had raised interest rates in response to mounting inflationary pressures, while the International Monetary Fund had revised its global inflation projections upward.

It reiterated that sustained fiscal discipline and timely structural reforms would remain essential to strengthening Pakistan's resilience and supporting sustainable economic growth.