Hopes for a sustained period of cheaper borrowing suffered a major setback on Thursday, March 26, as the State Bank of Pakistan accepted sharply higher yields in its latest auction of fixed-rate Pakistan Investment Bonds, reflecting mounting market anxiety over rising oil prices and escalating geopolitical tensions.
The central bank raised Rs 466.2 billion against a target of Rs 400 billion, but at a significantly higher cost. Yields across the 2-year, 3-year and 5-year tenors converged at a flat 12.50 percent level, marking steep increases compared to the previous auction held on February 6.
The cutoff yield for the 2-year bond rose to 12.5000 percent from 10.3380 percent, an increase of 216.24 basis points, with Rs 42.1 billion accepted. The 3-year bond saw the sharpest jump, climbing to 12.5000 percent from 10.2489 percent, up by 225.16 basis points, while the government raised Rs 65.5 billion in that tenor. The 5-year paper also closed at 12.5000 percent, rising by 175 basis points from 10.7500 percent, with Rs 33.6 billion accepted.
In contrast, the government rejected all bids for the 10-year bond despite a previous cutoff yield of 11.2390 percent, signaling reluctance to lock in borrowing costs at elevated levels for a decade.
The standout feature of the auction was the 15-year zero-coupon bond, which absorbed the bulk of the liquidity, with Rs 325 billion accepted at a cutoff yield of 12.4000 percent, up by 90 basis points from 11.4998 percent in the previous auction. The heavy reliance on long-term funding despite higher rates underscores the government’s growing financing needs amid tightening fiscal conditions.
Market analysts linked the sharp rise in yields to a sudden deterioration in the external environment, particularly the surge in global oil prices triggered by intensifying conflict in the Middle East. Oman crude futures reportedly climbed to around $152 per barrel during the week, dramatically altering inflation expectations and forcing investors to demand a higher risk premium on government securities.
The impact has already begun to filter through the domestic economy. Fuel prices were recently increased by Rs 55 per litre, and economists now expect inflation for March to range between 7 percent and 7.5 percent, slightly higher than February’s reading of 7.0 percent. Elevated energy costs are widely seen as a key obstacle to bringing inflation down toward the government’s medium-term target range of 5 to 6 percent.
The auction outcome has also triggered a reassessment of interest rate expectations. Only weeks ago, markets were betting that the policy rate, currently at 10.5 percent, would fall into single digits by mid-2026. However, by accepting yields around 12.5 percent, authorities have effectively acknowledged that the market’s required return on government borrowing has moved significantly above the policy rate, creating what analysts describe as a de facto tightening of financial conditions.
The development carries serious fiscal implications. Federal borrowing has already doubled this year to approximately Rs 2.45 trillion, and each 100 basis point increase in Pakistan Investment Bond yields adds substantially to the government’s debt servicing burden. Rising financing costs could further constrain development spending and limit the government’s ability to provide subsidies, particularly in the energy sector, where circular debt pressures continue to mount.
Economists caution that if oil prices remain elevated and inflation stays above expectations in the coming months, policymakers may be forced to maintain a cautious stance or even consider defensive measures to protect the rupee and contain inflation. In that scenario, the prospect of interest rate cuts could remain on hold for longer than previously anticipated.
The latest bond auction therefore signals a clear shift in market sentiment. Investors have begun pricing in a persistent geopolitical risk premium, suggesting that the near-term outlook may be defined by higher borrowing costs, tighter financial conditions, and prolonged pressure on public finances.
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