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With the last downward revision of policy rate to 11 percent in May’25, the intriguing question for FY26 is whether the easing cycle has ended and FY26 will witness a ‘trough’ year for policy rate or more easing/tightening is on the horizon with expected inflation of 7-8 percent during FY26?
Instead for looking at the crystal ball for answers, it would be interesting to look at the historical trend of Policy rates during the last 10 years and infer some stylistic views or indulge in casual empiricism for answers.
An upfront two caveats are in order: Ideally to ascertain a robust pattern in rates cycles a longer period of observed rate cycles is desirable, but this analysis is circumscribed by the fact that Policy (target) rate instrument was introduced in 2015. Secondly, periodic policy rates announcements are based on complex interaction of current and expected external and structural/intertemporal challenges facing the economy.
Only inflation rate and changes in PKR/USD will tangentially accompany the current rate cycles discussion. For graphical depiction of SBP trade cycles see: https:// tradingeconomics.com/pakistan/interest-rate.
Starting with two peaks in the rates cycle during the 10-year period, the first peak of 13.25 percent from a low of 6.0 percent in Jan 2017 was reached in July 2019. The duration of the peak was 8 months. Easing of the policy rate began in Feb 2020.
The corresponding CPI annual rate of inflation rate in 2019 and 2020 was 10.58 and 9.74 percent respectively, yielding roughly a positive real rate of 3-4 percent. The rupee depreciated by 19.3 and 13.9 percent during FY19 and FY20 respectively. Note the duration of interest rate peak was roughly in line with the PKR/USD depreciation.
The second peak of interest rate cycle of 22 percent occurred in June 2023 and lasted till May 2024 (11 months). The tightening began from a policy rate of 7 percent in Aug’21. Inflation rate around this period of 2023/2024 of tightening cycle and peak ranged between 29 and 13 percent, fluctuating between negative and positive real return. Average depreciation of PKR/USD during FY23 and FY24 was 28.5 and 12.32 percent, respectively.
In the second peak, the depreciation of the rupee preceded the peak of the interest rate. In comparing the duration of two tightening cycles, the first peak was reached in 18 months and the second peak was reached in 14 months, with similar troughs, but almost 66 percent higher peak (22 percent vs13.25 percent). Without implying established empirical causality, it may also be due to higher depreciation post FY22.
As there is likelihood of approaching the third trough, the insights offered by past two troughs are more relevant and meaningful as compared to previous two peaks. The first trough occurred at 5.75 percent. It lasted 19 months from May 2016 to Dec 2017.
The average CPI inflation rate during 2016and 2017 was a low of 2.3 and 3.8 percent, respectively, yielding a positive real interest rate between 2-3 percent. Corresponding average depreciation rate of PKR/USD in FY2016 and FY2017 was 2.82 and 0.44 percent, respectively.
The second trough of 7 percent policy rate occurred for 14 months from June 2020 to Aug 2021. It yielded negative real rate of interest as inflation rate in 2020 and 2021 was 9.75 and 9.5 percent respectively.
In FY2019 and FY2020, the rupee depreciation of 19.3 and 13.9 percent respectively, preceded ‘trough’ rate without any tightening of the monetary policy.
A tentative presumption is that the economy had to pay the cost of delayed policy rate adjustment in terms of higher inflation rate for 3 years, from 2022 (12.15 percent), 2023 (29.2 percent) and 2024 (13.66 percent). Comparing the life (duration) of both troughs, the life of second trough was shorter (14 vs 22 months) and its trough rate was higher (7 vs 5.75 percent).
What does the above short history of two troughs indicate for the third trough? Most likely the third trough will start above 7 percent, between 9 and less than 11 percent. If the SBP announcements in the 1st half of FY26 are implicitly influenced by the politically popular ‘single digit’ syndrome and black box of promoting private investment (which again is nothing than investing in casino economy) and public investment (grandiose infrastructure projects), the third trough is likely to begin in Jan’26 between 9 and 10 percent and, its duration will likely be shorter than 14 months.
Another tentative finding that emerges at the national level, from the above stylistic view, is that interest rate tightening and easing trends should be more sensitive to expected ex-ante PKR/USD movements and thereby to imports and exports, rather than ex-post inflation rates, because it is an import-based consumption-oriented economy. Moreover, the exchange rate has been slowly weakening since last two months, again partly due to strengthening of the casino economy. Ideally the trough should start somewhere between 10 and 11 percent policy rate.
There are few generic economic factors different from the previous two troughs that can lead to the above tentative scenario. On the international front, there is considerable geo-economic uncertainty due to international trade friction and regional war, leading to unpredictable supply chains, thus keeping upward pressure on expected global inflation and thereby a lid on easing momentum of policy rates across countries.
At the national level, domestic and international debt levels have worsened since the last trough. In our zeal to push policy rate to single digit level will affect foreign flows (e.g., foreign retirement of T-bills) as well further weaken our propensity to buy domestic financial assets as rate of return between real and casino economy widens.
Fragile security, high energy costs, institutional and regulatory logjam do not offer an environment where productive investment in manufacturing will be responsive to even significant cut in policy rate. For policy makers at below 10 percent policy rate, the tradeoff is between promoting casino economy (superficial growth) and the stability of exchange rate and inflation.
Copyright Business Recorder, 2025
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