Torrential Rains and Flooding Pose Risks to Pakistan’s Economic Recovery, Warns SBP

Subdued inflation, relatively stable exchange rate, prudent fiscal policy, and the country’s improved credit rating are likely to support economic recovery in Pakistan, but recent torrential rains and flooding could pose some challenges to the economic recovery, according to a report released by the State Bank of Pakistan (SBP) titled “Mid-Year Performance Review of the Banking Sector.” The profitability of the banking sector remained steady despite a significant decline in interest rates. The after-tax profit of the sector grew by 27.1% in H1CY25 as compared to a sluggish growth of 1.1% in H1CY24. The asset base of the banking sector expanded by 11.0% in H1CY25 to stand at 59,572 billion, primarily supported by an increase in investments while advances contracted. The recent heavy floods may weaken the repayment capacity of agri borrowers; however, the banking sector’s soundness is likely to remain immune due to a relatively contained share of agri advances in the overall loan portfolio and adequate capital cushions available with the banks. With a relatively lower tariff rate of 19% compared to regional competitors, textile exports to the US may see some uptick, translating into higher credit demand. While continued fiscal consolidation, realization of planned official inflows, and an increase in non-tax revenue can taper the government’s needs for bank credit, recent flooding could exert pressure on the fiscal account. The banking sector’s performance is likely to remain steady in the second half of 2025. The earning as well as solvency position of the banking sector is likely to remain steady, whereas the cumulative reduction in policy rate is likely to depress banks’ interest earnings. With an expected rise in lending amid easy monetary and improving economic conditions, the volume effect on earnings may outweigh the rate impact. The credit risk of the banks is expected to remain contained owing to anticipated improvement in repayment capacity of the borrowers amid easing financial conditions, improved business confidence, and further traction in economic activity. Encouragingly, results of the latest macro stress tests suggest that the banking sector, in general, and the large systemically important banks, in particular, are expected to show resilience and withstand assumed severe macroeconomic shocks over the projected period of two years. Amid easing financial conditions, economic recovery, and a seasonal demand, banks’ advances are expected to rise in the second half of 2025. The contraction in advances was witnessed in both public and private segments, which reflects seasonal factors as well as reversal of a substantial increase in lending towards the end of CY24, largely attributable to ADR-linked tax policy and improvements in macro-financial conditions. On the funding side, after witnessing a contraction in H2CY24, deposits grew at an impressive pace of 17.7%, thus lowering banks’ reliance on borrowings, which remained almost stable over the period under review. Encouragingly, under different scenarios of stress testing exercises, the banking sector shows sufficient resilience to withstand severe shocks to key risk factors and hypothetical adverse economic conditions. The average volatility in the domestic financial market remained relatively higher during H1CY25, driven mainly by the equity market. The equity market continued its upbeat momentum amid improving domestic macroeconomic conditions, punctuated by a few bouts of heightened volatility during Q2CY25 in the wake of external factors such as the US trade tariff policy and regional and geopolitical tensions, which materially impacted the market sentiments. Improved FX reserves due to the current account surplus and financial inflows kept FX market volatility under check, while the money market continued to operate smoothly.