On May 5, 2025, the State Bank of Pakistan (SBP) announced a highly anticipated move: the reduction of its benchmark interest rate by 100 basis points, bringing it down to 11% from 12%. This marks a significant pivot in Pakistan’s monetary policy strategy after nearly two years of aggressive tightening. The central bank’s decision, which came amidst easing inflationary pressures, sluggish economic recovery, and an increasingly tense geopolitical environment, is being closely scrutinized by economists, investors, and international partners. While the reduction aims to boost growth, it comes with layered implications, both positive and potentially adverse, for the country’s long-term economic stability. The decision was largely prompted by the significant drop in headline inflation. According to the Pakistan Bureau of Statistics (PBS), inflation stood at a mere 0.3% in April 2025, compared to 0.7% in March and over 36% during the same period in 2023. This sharp decline is credited primarily to a fall in food and fuel prices-particularly wheat, sugar, edible oil, and petrol-underpinned by stable global commodity prices and robust domestic supply-side management. The SBP’s own projections for headline inflation for fiscal year 2024-25 have been revised downward to between 5.5% and 6.5%, a significant improvement over previous years. This disinflation has created critical room for the central bank to lower borrowing costs. During its peak tightening phase in June 2024, the SBP had pushed the interest rate to a record 22%, one of the highest in the region, in a bid to rein in spiraling prices and stabilize the rupee. While this strategy tamed inflation, it also constrained business activity and discouraged consumer borrowing. As a result, real GDP growth for FY2023-24 barely scraped 2.5%, according to the Ministry of Finance’s economic review. By reducing the policy rate to 11%, the SBP hopes to reignite investment, ease credit flow, and accelerate economic activity, particularly in key sectors like manufacturing, construction, and agriculture. The impact of this policy shift on the business environment is expected to be tangible. Small and medium enterprises (SMEs), which form the backbone of Pakistan’s economy and contribute nearly 40% to GDP, had long complained of being priced out of formal credit markets due to exorbitant borrowing costs. The new rate is expected to reduce commercial lending rates from an average of 17-18% to more affordable levels. In turn, this could stimulate expansion in SME operations, especially in export-oriented industries such as textiles, garments, and pharmaceuticals. In addition, the construction sector-another major employment generator-is likely to receive a fresh boost as mortgage and project financing becomes more accessible. The political fallout has already begun to manifest in the economic realm. However, the rate cut was not taken in a vacuum and comes amidst serious macroeconomic and geopolitical headwinds. The deadly April 23 attack in Indian-administered Kashmir, which killed over two dozen civilians, has reignited cross-border tensions between Pakistan and India. In its aftermath, both countries have downgraded diplomatic engagement and curtailed trade. The political fallout has already begun to manifest in the economic realm. For instance, Pakistan’s sovereign bond spreads widened sharply by 200 basis points within days of the incident, crossing 850 basis points above U.S. Treasuries. This reflects investors’ heightened risk aversion and concerns over Pakistan’s fiscal capacity to service its external debt obligations. These concerns are further exacerbated by a modest reserve position. As of late April, Pakistan’s foreign exchange reserves stood at $10.5 billion-higher than the 2024 lows of $4 billion, but still below the SBP’s targeted cushion of $14 billion. The rupee, although stabilized around Rs. 282 to the USD, remains vulnerable to external shocks. Any sudden capital flight or surge in import demand due to looser monetary conditions could put fresh pressure on the current account and foreign reserves, threatening the stability achieved over the past 12 months. Adding another layer to the monetary calculus is Pakistan’s engagement with the International Monetary Fund (IMF). On May 9, the IMF is scheduled to conduct a crucial review of Pakistan’s ongoing $7 billion Extended Fund Facility (EFF) program. A positive review is necessary for unlocking the final tranche of $1.1 billion. Moreover, Pakistan is in talks with the IMF to secure an additional $1.3 billion loan under the Resilience and Sustainability Trust (RST) to support climate adaptation. The IMF typically favors a tight monetary stance to anchor inflation expectations and build reserve buffers. While the SBP’s decision to cut rates is internally justified by inflation data, it could be viewed cautiously by the Fund, particularly given Pakistan’s still-elevated fiscal and external vulnerabilities. From a long-term perspective, the rate cut could have mixed consequences. On the positive side, lower rates could usher in a new investment cycle. Pakistan’s private investment-to-GDP ratio has stagnated around 10%-among the lowest in South Asia-largely due to high cost of capital and regulatory bottlenecks. If supported by structural reforms, the rate cut can improve the credit environment and lift private sector confidence. Furthermore, job creation could improve, especially among youth, as dormant industries restart expansion plans and boost hiring. On the downside, easing monetary policy too quickly can undermine gains made on the inflation front. Core inflation, which excludes food and energy prices and serves as a more stable measure of price pressure, remains elevated at around 8.4%, as per SBP estimates. A premature loosening of rates can stoke demand and destabilize inflation expectations, particularly if energy prices surge due to renewed Middle East tensions or global supply chain shocks. Moreover, a consumption-driven recovery-if not accompanied by exports and productivity gains-may widen the current account deficit once again, exposing the economy to renewed balance of payments stress. Market analysts and economists are divided on the long-term impact of the rate cut. Some, like Dr. Khaqan Najeeb, a former economic advisor to the Ministry of Finance, argue that the SBP has “wisely created space for private sector credit without losing sight of external vulnerabilities.” Others, like Dr. Hafeez Pasha, caution that “Pakistan’s room for monetary easing is limited, and the real game lies in reviving investor trust and managing external liabilities.” Both perspectives reflect a broader truth: the efficacy of interest rate policy depends on how well it is synchronized with fiscal consolidation, energy sector reforms, and improved governance. The SBP’s decision to cut the policy rate to 11% is a double-edged sword. On one hand, it signals confidence in the country’s inflation trajectory and seeks to revive investment and growth. On the other, it exposes the economy to risks stemming from geopolitical instability, fragile external balances, and premature inflation resurgence. For this monetary easing to bear fruit, it must be accompanied by consistent policymaking, reform momentum, and diplomatic prudence. Only then can Pakistan turn this policy shift into a catalyst for inclusive and sustained economic recovery. The writer, a chartered accountant and certified business analyst, is serving as a CEO for Model Bazaars.