Muhammad Sarfaraz Alam
Pakistan’s claims of steering the economy towards recovery, revitalising industrial activity and creating a conducive environment for investment have once again come under scrutiny. The State Bank of Pakistan (SBP) has announced a 50-basis-point increase in its policy rate, raising it from 11.5 per cent to 12 per cent, effective October 27, 2026. The decision comes at a time when the country’s industries are already struggling with high production costs, expensive energy, heavy taxation and limited business opportunities.
The central bank maintains that the increase was necessary to contain inflationary pressures arising from the escalating conflict in the Middle East, rising global crude oil prices and their potential second-round effects on domestic prices. However, a fundamental question remains: can inflation driven by external factors be effectively controlled by making domestic businesses, investment and production even more expensive? And will this decision address the underlying causes of inflation, particularly those associated with energy, supply chains and production costs?
The primary objectives of monetary policy are price stability, financial system stability and the creation of conditions conducive to sustainable economic growth. When inflation rises, central banks generally increase interest rates to restrain borrowing, consumer spending and investment. By moderating aggregate demand, this approach can help ease pressure on prices.
However, in a country like Pakistan, where inflation is largely driven by electricity, gas, petroleum products, raw materials and the cost of producing and transporting essential goods, the consequences of higher interest rates become more complicated.
According to the SBP, inflation stood at 10.3 per cent in September, while core inflation was approximately 8.4 per cent. The central bank aims to bring inflation within its target range of 5–7 per cent. Yet, if rising prices are primarily driven by international oil prices and domestic energy tariffs, increasing interest rates cannot directly address these underlying pressures.
Higher interest rates make borrowing more expensive for businesses, raising their production costs. Consequently, some enterprises may be compelled to increase the prices of their products. In certain circumstances, therefore, a policy intended to contain inflation may inadvertently contribute to cost-push inflation.
The SBP has maintained its economic growth forecast for the current fiscal year at 3.5–4.5 per cent. During July and August, large-scale manufacturing recorded annual growth of 1.9 per cent, while private-sector credit registered a year-on-year increase of 14.1 per cent.
These indicators suggest an improvement in industrial activity. Rising cement and petroleum product sales, alongside improved agricultural prospects, also provide encouraging signals for the economy.
However, an increase in the policy rate could undermine this recovery. Businesses may postpone expansion plans, restrict purchases of new machinery and become less capable of generating employment opportunities.
Expensive financing is particularly challenging for small and medium-sized enterprises (SMEs). While larger corporations may have access to alternative financing sources, obtaining bank loans at high interest rates is often unaffordable for smaller businesses.
The country’s leading business organisations have expressed strong reservations about the increase in the policy rate. Their common position is that Pakistan needs lower production costs, greater investment and stronger exports rather than expensive financing.
Federation of Pakistan Chambers of Commerce and Industry (FPCCI) President Atif Ikram Sheikh has strongly opposed the increase to 12 per cent, describing it as detrimental to Pakistan’s economic competitiveness. According to him, industries are already burdened by high energy tariffs and production costs. The increase could adversely affect investment, industrial output and employment. He has called for the policy rate to be brought down to single digits.
Federation of Pakistan Business and Industrial Trade (FBATI) President Syed Raza Hussain believes that high interest rates will make it increasingly difficult for export-oriented industries and SMEs to compete in international markets. He maintains that expensive financing is a major obstacle to fresh investment and industrial expansion. He has called for affordable loans for industry and a business-friendly environment.
Karachi Chamber of Commerce and Industry (KCCI) President Talat Mahmood has also opposed the increase, arguing that the principal drivers of inflation are rising energy and fuel prices, supply-chain disruptions and geopolitical uncertainty. In his view, raising interest rates cannot directly resolve these problems and will instead add to the cost of doing business.
Lahore Chamber of Commerce and Industry (LCCI) Vice President Chaudhry Khadim Hussain has likewise expressed concern over the rising cost of borrowing. He believes that expensive financing, combined with increasing energy and raw material costs, will place further pressure on the business environment. He has emphasised the need for consultation with the private sector and affordable financing for SMEs.
Association of Builders and Developers of Pakistan (ABAD) Chairman Muhammad Hanif Gohar has described the increase in the policy rate as another major challenge for the construction industry. According to him, higher interest rates will increase the financing costs of construction projects, potentially delaying new developments and obstructing the completion of ongoing projects.
Pakistan already faces a housing shortage of approximately 10 million units. Any further increase in construction costs will make homeownership even more difficult for ordinary citizens.
Moreover, more than 100 allied industries are linked to construction activity. Cement, steel, tiles, electrical equipment, timber, transportation and labour services are among the sectors whose employment and output depend heavily on construction.
A slowdown in construction is therefore not merely a concern for builders and developers; it can also undermine employment, industrial production and urban development.
According to the SBP, Pakistan recorded a current account deficit of $874 million in the first quarter. The import bill is projected to exceed $71 billion during the current fiscal year, while exports are expected to remain between $32.5 billion and $33 billion.
This situation highlights the need for effective import management and a fundamental expansion of exports to ensure external account stability.
Higher interest rates may temporarily help restrain demand and imports, but they do not resolve structural weaknesses in export competitiveness, industrial technology, energy costs or productive capacity.
Furthermore, higher interest rates can increase the government’s domestic debt-servicing burden. If a substantial portion of public resources continues to be consumed by interest payments, fewer funds will remain available for development projects, education, healthcare and industrial infrastructure.
Pakistan needs a comprehensive economic strategy to control inflation rather than relying solely on interest rate increases.
First, immediate measures should be taken to reduce energy tariffs, electricity-sector losses and production costs, providing meaningful relief to industries.
Second, the SBP should establish a clear and credible pathway for gradually reducing interest rates, taking inflationary trends and economic growth into account. As inflationary pressures ease, affordable financing should become more accessible to businesses.
Third, targeted financing schemes should be introduced for SMEs, export-oriented industries and employment-generating sectors to ensure that credit supports productive economic activity.
Fourth, the government must take practical steps to reduce the fiscal deficit, improve tax collection and curtail unnecessary expenditure. Sustainable inflation control will remain difficult without coordination between fiscal and monetary policies.
Finally, consultation with the business community, industrialists and exporters should become an integral part of economic policymaking.
The SBP’s decision to raise the policy rate to 12 per cent is undoubtedly an attempt to address potential inflationary risks. However, its success will depend on whether it genuinely eases price pressures or instead increases business costs, discourages investment and aggravates employment challenges.
Pakistan needs an economic policy that strikes a balance between price stability and economic growth. Controlling inflation is essential, but weakening industries, discouraging investment and restricting employment opportunities cannot constitute a sustainable solution.
The path to economic recovery lies in affordable energy, lower production costs, competitive exports, effective fiscal discipline and a business-friendly environment. Any decision to increase or decrease interest rates must be assessed within this broader economic context.
About the Author:Muhammad Sarfaraz Alam is an economic analyst, journalist, and researcher. He holds an MSc in Economics from the University of Karachi. He writes analytical articles and columns on economic, political, and social issues, with his work regularly published in various newspapers, journals, and magazines.
