The discount rate is the interest rate that the State Bank of Pakistan charges commercial banks when they borrow money from its discount window to meet short-term liquidity needs. This interest rate is not directly linked to the interest rates that banks charge their borrowers, but it is very closely correlated with the Karachi Interbank Offer Rate (Kibor), which is used in most lending contracts as the benchmark interest rate.sbp monetary policy 2012

The move is likely to have a negative impact on the profitability of the banks, which have already seen a steady decline in their net interest margin: the difference between the rate that they charge their borrowers and what they pay out as interest payments to their depositors.

In a statement issued to the press, the State Bank justified the cut by pointing to the slowing rate of inflation over the past several months. The consumer price index – the main measure of inflation in the economy – dropped below 9% for the first time in nearly six years in September, leading many analysts to predict that the central bank would continue with its recent spate of interest rate cuts.

Yet, even though the move had been anticipated for several days now, the actual cut nonetheless surprised many analysts who had been anticipating a 1% reduction in the benchmark interest rate, which would have taken the discount rate below the psychological 10% barrier. In the end, the State Bank appears to have exercised caution and cut the rate to exactly 10%, disappointing those who had been hoping for a single-digit benchmark rate.

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Others, however, felt that the size of the rate cut was justified at the current level. “The Karachi Stock Exchange has rallied since the inflation announcement for September, which suggests that the market has priced in a 50 basis point [0.5%] cut in the discount rate,” said Furqan Punjani, research analyst at BMA Capital, in a note issued to clients on Wednesday. Punjani noted that the bond market also appeared to have been anticipating the interest rate to go down to 10%, with prices on government bonds rising to reflect a yield closer to that mark.

The discount rate is now at its lowest since the current Pakistan Peoples’ Party-led administration took office. The last time the rate was this low was in January 2008, right before the State Bank announced an increase to 10.5% at the end of that month. The last time the economy had single-digit interest rates – at least at the benchmark level – was in July 2007.