By Azam Tariq

Despite continued foreign investor outflows, Pakistan’s financial markets remained broadly stable in 2025, supported by improving macroeconomic fundamentals and strong participation from domestic investors, according to the Financial Stability Review 2025 released by the State Bank of Pakistan (SBP).

The report indicates that while foreign investors remained net sellers in the equity market during the year, the resulting pressure was effectively absorbed by local participants, including mutual funds and individual investors. This shift in market dynamics helped maintain overall stability and ensured that liquidity conditions remained adequate despite external uncertainties.

The SBP noted that stability in financial markets was underpinned by improving macroeconomic indicators, including declining inflation, a stable exchange rate, and strengthening foreign exchange reserves. These factors helped restore investor confidence and reduce volatility across key segments of the financial system, even amid fluctuations in global financial market.

The money market continued to function in an orderly manner throughout 2025, reflecting effective liquidity management by the central bank. Short-term interest rate movements remained aligned with the monetary policy stance, and market conditions remained predictable, supporting financial intermediation and economic activity.

In the foreign exchange market, improved reserve levels and steady inflows helped maintain stability in the rupee-dollar parity. The SBP’s market-based interventions, combined with easing external pressures, helped maintain orderly market conditions and reduced the likelihood of sharp currency fluctuations.

The report highlights that despite the stable environment, financial markets experienced slightly higher volatility compared to the previous year, mainly driven by movements in the equity market. External factors, including geopolitical tensions and uncertainty in global trade policies, contributed to short-term fluctuations in investor sentiment.

Domestic institutional investors played a critical role in sustaining market stability. Mutual funds, in particular, absorbed a significant portion of the selling pressure from foreign investors, while individual investors also increased their participation in the market. This growing reliance on domestic capital has helped reduce vulnerability to external shocks and enhanced the resilience of financial markets.

The SBP also noted that progress in macroeconomic stabilization, including fiscal consolidation and continued engagement with international financial institutions, supported overall market confidence. Improvements in country risk indicators and credit ratings further strengthened the  stability of the financial environment.

However, the report cautioned that financial markets remain exposed to external risks, particularly those arising from global financial conditions, commodity price volatility, and geopolitical developments. Any adverse changes in these factors could affect capital flows and market stability.

Maintaining financial market stability will require continued policy discipline, effective regulatory oversight, and efforts to deepen domestic capital markets, which can further strengthen resilience against external shocks.

Credit: INP-WealthPk