Pakistan’s central bank recently reduced the policy rate by 250 basis points (bps), bringing it down to 15%. This unexpected and substantial rate cut, which exceeded market expectations of a 120-150 bps reduction, represents a strategic shift aimed at reducing the government’s borrowing costs and strengthening the country’s fiscal health.
Key Outcomes and Macro Impacts
1. Immediate Debt Relief:
The rate cut is expected to lower Pakistan’s fiscal year 2025 (FY25) interest payments by approximately Rs 1.3 trillion, reducing total interest expenses from the projected Rs 9.8 trillion to about Rs 8.5 trillion. This savings of around 1% of GDP could significantly ease Pakistan’s debt servicing costs, creating fiscal space that may exceed Rs 2.5 trillion, or about 2% of GDP, as further rate cuts are anticipated.
2. Strengthening Fiscal Management:
With reduced interest payments and prudent debt management, Pakistan’s fiscal outlook appears to be improving. The fiscal deficit, initially estimated at 6.9% of GDP, is now projected to drop to as low as 5% of GDP—potentially the lowest in recent history.
3. Inflation and External Account Stability:
By controlling new debt issuance and focusing on productive spending, the government can help contain inflation and stabilize the money supply. These measures are also expected to strengthen Pakistan’s external account, potentially bolstering the rupee and boosting foreign reserves.
4. Lower Business Costs Amid Declining Oil Prices:
The combination of lower interest rates and declining global oil prices should reduce the cost of capital, making it easier for the private sector to operate and encouraging new investments. This, in turn, can lower energy costs and drive economic growth.
5. Enhanced Investment Climate with Tax Reform:
Expanding Pakistan’s tax base by targeting untapped sectors such as agriculture, retail, and property could further stimulate the economy. A more balanced tax structure would relieve pressure on the formal sector, creating a favorable environment for investment.
6. Investment Strategy:
The rate cut positions various asset classes for growth in the current economic landscape. Domestic equities, which have rallied 12.5% since the September 2024 Strategy Report, are expected to continue performing well, especially as the market’s forward multiple remains at a discounted 6x. Infrastructure, financial services, and consumer goods sectors are likely to benefit most. Additionally, government bonds offer steady returns amid stable fiscal policies, while real estate investments are attractive due to reduced borrowing costs and strong growth potential.
In summary, Pakistan’s significant rate cut is expected to support fiscal discipline, reduce the fiscal deficit, manage inflation, and improve the investment climate. Paired with continued fiscal reforms, these measures could pave the way for sustainable economic stability and robust growth.
