Rupee depreciation to surge inflation with MoF and SBP keeping its silence

Muhammad Arif

Depreciation of PKR was overdue. Some say that due to departure of Ishaq Dar who kept the PKR value first at Rs 98 and then at Rs 105 and then at Rs 110 artificially, this all is happening. But to keep the government finance through borrowing has to result like this and this Ishaq Dar did in his tenure.
Now Miftah Ismail and Rana Afzal are doing the job with no ideas and no plans. So this was apparently to happen with no expert or economist even sitting in SBP.
On 20th March 2018 rupee depreciated Rs7.5 against the US dollar to Rs118.0 in the inter-bank market compared to its closing rate of Rs110.5 on 19th March 2018. According to SBP press release the PKR-US$ exchange rate in the interbank market closed at PKR 115 per US$ on 20th March 2018 whereas rupee closed at Rs117 against the US dollar in the open market on the same date. This appears to be currency devaluation by SBP, traders say, the second since December last year.
In December 2017 nearly 5 per cent depreciation of the Rupee occurred. Multiple signals indicated at that time that pressure on the currency would continue. An IMF report released earlier also stressed on the need for “greater exchange rate flexibility on a more permanent basis” to preserve external buffers and international competitiveness.
With the current depreciation in the rupee, participants of the stock market can expect the much-awaited increase in foreign buying leading to a positive overall impact. The textiles, power and software are likely beneficiaries while the auto sector is going to get an adverse hit.
IMF’s post programme report released also welcomed the central bank’s decision to permit Pakistani rupee to depreciate against the dollar in early-December 2017 but emphasized on the significance of greater exchange rate flexibility on a more permanent basis to enhance competitiveness and safeguard external buffers.
A United Nations report in early-December warned Pakistan’s policy of keeping the rupee stable could become untenable if the US dollar appreciates against other world currencies and possibly erode the country’s foreign exchange reserves.
A World Bank analysis in November 2017 revealed a weaker Pakistani rupee would help external balances with limited economic costs.
WB analysis outlined that there was a significant co-relation between the Real Effective Exchange Rate (REER) and exports in the medium to long-term. A flexible Pakistani rupee would allow in narrowing the current trade deficit.
In July 2017, Moody’s Investor Service said the rupee was 20 per cent overvalued and had urged the State Bank of Pakistan (SBP) to show some flexibility and let the PKR depreciate.
The PKR depreciation occurred mainly to the country’s external Balance of Payments position and widening of current account deficit that translated into a demand- supply gap of foreign exchange. The current account balance as of CY 2017 stands at -$15.6 billion as compared to -$7.0 billion last C.Y. FX Reserves stand at $ 12.1 billion as on March 2018 as compared to 16.5 billion in March 2017. Government external debt as of Feb 2018 stands at $ 6.8 billion as compared to $ 5.4 billion as on June 2017.
Huge uncertainty exists in the currency markets now as banks are looking tight-lipped. In response to Reuters, State Bank of Pakistan’s (SBP) Qamar said it was triggered by “some payment pressures which are building within the market” and added that the central bank would be “observing the market where it is moving towards.”
Now the more important question is how much depreciation is warranted. For evaluating that there is a need to see the impact of currency fall relative to trading partners. The indictor best covering this aspect is Real Effective Exchange Rate (REER), there are number of ways to compute REER, let’s stick to the model computed by the IMF and published by the SBP.
The REER was at 124.1 in Nov 17 and it has come down to 115.1 on Jan 18. The depreciation against USD, before 13th March depreciation, was a mere 4.7 percent while the REER is down by 7.8 percent. The reason for higher REER drop is that the USD is weakening against global currencies and depreciation of PKR against Euro, British Pound and Japanese Yen was 9.2 percent, 9.4 percent and 11.4 percent, respectively. That is a decent number and another round of similar adjustment of rupee against USD to take the currency level Rs 120/USD by June 2018. That would bring the REER to its equilibrium value – square 100 marks.
This is one way to see the equation. However, the IMF is more concerned on the external woes; as per IMF latest country report, the net international reserves were minus $724 million in Feb18 versus $7.5 billion in Sep 16 when the Fund programme was concluded. The fall of $8.2 billion in 18 months is a cause of concern and the fund would look at it closely and may push authorities to depreciate rupee further.
The point is that IMF may push for higher depreciation than what is warranted before we enter into fund programme; and the need is to negotiate the case of less depreciation strongly. The need is to keep the currency at current level (Rs 115-116 per USD) till June and if needed, take it down to Rs 120 per USD and then sit tight to reap depreciation fruits. Any further slide in currency from Rs 120/USD would be counterproductive.
State Bank of Pakistan (SBP) says that further depreciation of Pak rupee entirely depends on export-import data and home remittances in the coming months. Sources have quoted an official of SBP as saying that he is presenting facts and figures on the basis of which the central bank thought it necessary to depreciate the rupee.
He said, exports increased by 11.5 per cent whereas imports rose by 23 per cent which led to a massive increase in the current account deficit due to which country’s reserves decreased by $ 3.4 billion by November 30, 2017 from $ 12.6 billion as compared to $ 16 billion as on June 30, 2017. The current account deficit is at -$11.235 billion as of July 17 to March 18 as compared to -$.4.008 billion as of July 2016-March 2017
Due to a significant drop in foreign exchange reserves, SBP was and is compelled to take steps to deal with the situation. Some steps were initiated by the federal government including measures to discourage unnecessary imports for example the imposition of Regulatory Duty (RD) and cash margin on non-essential items in addition to an export incentive package. The purpose of all these steps was to improve balance of payments.
An assessment is, that with this step the pace of growth in imports will decline and exports will be encouraged,”SBP says. SBP official states that further steps would be taken on the basis of fresh data of balance of payments.
On positive side SBP official says that there was a significant increase in Foreign Direct Investment (FDI) during the last five months of current fiscal year which was around $ 1.5 billion showing a growth of 65 per cent. According to him, when reserves dropped to $ 12 billion import coverage also decreased, adding that SBP intends not to let reserves drop lower than $ 14 billion. Currently SBP”s target is to maintain 2.5 month to 3 months import coverage.
Ministry of Commerce and Textile is saying that most Asian currencies have been depreciating against the USD in the last 5 years. This largely reflects the currency war that central banks have been waging against one another in order to protect their export industries. As an emerging market, many of the Asian countries are heavily reliant on export industries (i.e. manufacturing) to grow their economics and cheaper currencies are a major tool to make a nation’s products cheaper than other nations”. The net effect has been that everyone’s currencies have devalued; effectively negating the simulative effect those exchange rates could have on exports. However, Pakistan continued to maintain an overvalued exchange rate that made Pakistan’s exports uncompetitive vis-a-vis regional competitors. The current devaluation would enable Pak rupees to be at parity with the regional currencies, which is believed to be highly overvalued as compared to its real exchange rate.
As far US currency is concerned the dollar index has dropped 2.5 per cent so far this year, and no one seems to agree about why the US currency has been soft in 2018 but this is happening due to trump on the helm of affairs.
So things are looking messy everywhere particularly in Pakistan where its 60% population is either below poverty line or just marginally above. With one fourth of its imports are of oil and petrol items and sooner Pakistanis would see heavy surge in oil prices impacting every item in Pakistan. A notable economist has predicted that after elections PKR would further depreciate to Rs 150 per US Dollar if things moved like this without change in its policies.
The main question hence, now emerge that whether high-up’s at MOF or SBP can do something or leave their seats for some others with better steps and plans.

Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), former Head of FSCD SBP, former Head of Research Arif Habib Investments and Member IFSB Task Force for development of Islamic Money Market, former Member of Access to Justice Fund Supreme Court of Pakistan.

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