The monetary policy is expected to be announced next week. The State Bank of Pakistan (SBP) has already slashed interest rates by half from their peak to 11 percent. Yet, monetary transmission remains elusive.

Aggregate demand is still sluggish, as evidenced by low GDP growth and lagging private sector credit. Inflation shows no signs of a significant upsurge. Based on these factors, there may still be room for another 100 to 200 basis points cut before hitting the policy floor.

The question is not just if the SBP should cut rates but how fast it should move. The main concern is external account slippage and its implications for the currency and, in turn, inflation. There is a delicate interplay between exchange rate management and the interest rate path.

Already, the currency is under pressure, and the dollar is perceived to be in short supply in the interbank market. This calls for a cautious approach by the Monetary Policy Committee.

One key indicator is the differential between US and Pakistani treasury bill/bond yields, which has a direct impact on foreign currency liquidity. Currently, the Pakistan–US treasury yield spread stands at 6.6 percent below the 20-year average of 8.1 percent. Historically, when the differential has dropped........

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