KARACHI, May 21: As Pakistan’s trade deficit has soared in ten months of this fiscal year to $4.84 billion from $2.05 billion during the same period of this fiscal year, this is bound to weaken the rupee. The Federal Bureau of Statistics released trade data for July-April 2004-05 which showed that Pakistan’s imports during this period stood above $16.36 billion and exports totalled $11.52 billion. Thus, the country saw a huge trade deficit of $4.84 billion within ten months of this fiscal year, which might reach around $6.5 billion at the end of the year in June. In the last fiscal year, trade deficit stood around $3.3 billion.
Since this deficit looks set to double in the current fiscal year, it would not only have adverse impact on Pakistan’s current external account and overall balance of payment but would also weaken the rupee. In ten months to April 2005, the rupee lost 2.3 per cent of its value against the US dollar in response to the rising trade deficit that created shortage of dollars in the market.
The rupee slide would have been steeper had the State Bank not been selling dollars to the banks to finance oil imports since November last. Between November 2004 and April 2005 the central bank sold more than $2.1 billion to banks essentially to help them finance soaring oil imports bill.
Oil import bill has been on the rise during this fiscal year in line with a progressive rise in international oil prices. But breakup of trade data of nine months of the current fiscal year show that import of machinery contributed more to the widening of trade deficit than the higher oil import bill did.
The SBP policy of providing dollars to banks against rupees for financing oil import bills has not only kept the rupee stable so far it has also soaked part of excess rupee liquidity from the banking system—thus playing its part in the SBP efforts to contain inflation.
Since the SBP had sold $2.1 billion in November-April 2004-05 this mopped up roughly Rs120 billion from the banking system. But a rapid growth in imports itself is contributing towards increase in the rate of inflation because despite SBP’s dollar selling the rupee has weakened to some extent and it has made imports costlier in terms of local currency. Moreover, importers, who know that the rupee would finally ease when SBP would stop or slow down dollar selling, are pricing their imported goods keeping this point in view. When imported goods become costlier it does affect the entire price line as even those goods that are not entirely imported but are manufactured using imported materials also become costlier.
Besides, as the rupee had lost 5.5 per cent of its value against the US dollar between July-November 2004 before the central bank started dollar selling to banks, imported inflation had a bigger hand in overall inflation.
The central bank continues to sell dollars but it would now have to reduce the sale because soaring trade deficit has made it difficult for the SBP to keep selling dollars without taking a hit on its foreign exchange reserves. But the local currency might not see any substantial fall in its value in the remaining period of this fiscal year and might come under pressure in the next year. The reason is that as the central bank has become aggressive in interest rates tightening to fight inflation it would not let the rupee fall to a big extent and make the task of interest rate tightening more difficult.
To tighten interest rates the central bank needs to keep the rupee liquidity levels as low as possible. This it does by conducting frequent open market operations — which in fact it is doing now -— and by dollar selling that also mops up excess liquidity. If it stops dollar selling the rupee liquidity would rise making the local currency cheaper. That in turn would make it difficult to keep rupee liquidity at low levels—-and the interest rates would automatically start declining nullifying the SBP efforts to tighten them and bring down rising inflation.
So it appears to be a matter of timing. Whereas currently the central bank is more focussed on interest rate tightening to check inflation it would eventually have to keep the rupee stable for some time. But since this does not seem practical for too long a time it would have to let the rupee decline with the result that interest rates would also start falling.
That in fact would suit the SBP because it does not want to keep interest rates too high for a long period. The current interest rate tightening is purpose-specific and as soon as inflation starts falling, the SBP would let interest rates also stabilize or even fall marginally to promote economic growth once again, which is going to slow down in the wake of the interest rate tightening. Pakistan economy is poised to grow more than 8 per cent during this fiscal year but in the next fiscal the rate of growth would be lower.
