Interest Rates May Remain Unchanged Despite Rising Inflation

Tresmark: Most analysts get interest rate forecasts wrong because they focus almost exclusively on inflation. That may work for a country like the US, but Pakistan’s MPC has to balance several competing objectives. Before deciding on rates, it will likely assess the following factors:
• Currency strength and the external account. Pakistan’s recent stability has been driven more by strong inflows and reserve accumulation than by interest rates.
• Is inflation demand-led or supply-led? Interest rates have limited impact on supply-side inflation. If the recent spike is driven by oil and geopolitical tensions, and a regional truce emerges in the coming days, some of that pressure could fade on its own.
• Twin deficits. The fiscal position and current account remain critical variables, particularly for an economy that has historically faced external financing constraints.
• Inflation trajectory. This is where things get interesting. Oil stubbornly refused to rally despite military strikes on Iran. The moment hostilities eased and Trump announced a peace deal is near, Brent moved lower. With China’s demand still looking soft, average oil prices appear unlikely to remain elevated for long. Inflation is projected to soften from August onwards.
• Global yields and Pakistan’s risk premium. This may be the most important piece of the puzzle. The ECB has hiked rates by 25bps but stopped short of signalling a sustained tightening cycle. The BOJ is expected to hike rates from 0.75% to 1%, while markets are increasingly debating whether the Fed may need to hike later this year after inflation moved back above 4%. Against that backdrop, Pakistan’s yields of around 12.5% still offer an attractive spread over US Treasuries at roughly 4.5%, even after adjusting for a materially improved CDS profile.

Taking all of the above into account, Tresmark’s research team expects the MPC to leave interest rates unchanged in Monday’s policy decision.

Remittances
Perhaps the most surprising development is not what has happened to oil or bond yields, but what hasn’t happened to remittances. Across Pakistan, Bangladesh, Nepal and Sri Lanka, inflows remain near record levels despite growing concerns around Gulf economies. More interestingly, the trend is visible across both Muslim and non-Muslim countries, suggesting this is not simply an Eid effect.

Yet on ground evidence from the Gulf points to a weakening labour market, softer hiring and growing uncertainty. The question, therefore, is whether remittances are proving genuinely resilient, or whether they are simply the last indicator to react to a slowdown that has already begun beneath the surface.

Key Budget Takeaways
Pakistan is trying to grow without spending. The budget provides targeted relief to sectors expected to drive activity, but the broader strategy remains IMF-led stabilization rather than a traditional growth budget.

1. The Budget Assumes Continued External Stability
Key assumptions include:
• Exports: $32.9bn
• Imports: $70.0bn
• Remittances: $42.4bn
• GDP Growth: 4.0%
• Inflation: 8.2%

The entire framework assumes the external account remains stable and remittances continue their recent momentum.

2. This Is an IMF Budget, Not a Growth Budget
The government is targeting a primary surplus of 2.0%, signalling that fiscal discipline remains the priority. Growth is expected to come from private sector activity rather than public spending.

3. Real Estate Gets the Biggest Relief
The construction and real estate sectors emerge as the largest beneficiaries, with multiple measures aimed at stimulating activity and encouraging investment.

4. Exporters Receive Meaningful Support
Several proposals are designed to improve competitiveness and support export-led growth, a key pillar of the government’s external sector strategy.

5. The Salaried Class Finally Gets Some tiny Relief
After years of bearing a disproportionate share of the tax burden, salaried individuals receive modest but welcome relief.

6. The IT Sector Remains a Favourite
The preferential 0.25% tax regime for IT exports has been extended until 2029, reinforcing the government’s commitment to one of Pakistan’s fastest-growing export sectors.