AS Pakistan skirts dangerously close to another stretch of ‘heavy weather’ on the balance of payments front, the Ministry of Finance and the State Bank of Pakistan are both seriously behind-the-curve in forestalling another panic attack on the rupee.

It has taken nearly two years for the State Bank to understand — and that too under IMF compulsion — that with scarce foreign exchange reserves, it primarily has a trade-off on its hands: it cannot preserve the country’s forex reserves, defend the exchange rate, and keep interest rates unchanged all at the same time.

In a combination of naivety and inexperience — and giving in to political expediency — it chose to squander nearly $3.5 billion of precious foreign exchange from its reserves to prevent the rupee from hitting a century against the US dollar.

It could have learnt a valuable lesson from the East Asian crisis. In 1997, in trying to keep the value of the baht stable, the Bank of Thailand (central bank) frittered away more than $10bn in a single week — before losing the battle against capital flight and succumbing to a huge devaluation of the currency.

In the given circumstances, interest rates are the central bank’s primary line of defence, supplemented by measures that will drain liquidity from the inter-bank market, and other measures that make imports more expensive. In addition, it needs to step up vigilance on capital flight and any delays in repatriation of export proceeds. This in a nutshell is the tried and tested template that the State Bank has followed since our all-too-frequent balance of payments difficulties from the early 1990s.

How do higher interest rates help in preventing pressure on the exchange rate?

Consider someone who is neutral to a decision to convert his or her rupee-denominated assets or cash holding to another currency. Let’s call this person an ‘economic agent’. With pressure on the rupee building up, and public expectations rising of a depreciation of, say, 10pc against the US dollar, our economic agent will now have an incentive to convert from rupees to US dollars — to preserve the value of her capital.

To pre-empt this, if the central bank raises the return on rupee deposits by 10pc or slightly more, the economic agent becomes neutral once again to the option of converting from rupees. This reduces the selling pressure on the rupee and punctures the excess demand for US dollars, thus maintaining equilibrium in the exchange rate market.

The finance minister, on the other hand, is distracted by ‘other’ supposedly pressing issues of a non-economic nature — at a time when the economy needs a steady and seasoned hand 24/7 at the helm to navigate through a difficult period.

As a close confidant of the prime minister, the finance minister had made the same mistake — to disastrous effect — in his brief stint in 2008. After announcing at a press conference that the economy was in far worse shape than what was known publicly, and shattering everyone’s confidence in the economy even further, he took the next flight to London with his party supremo to take up the ‘judges’ issue — without presenting any credible road map on how to get us out of the mess. After a few days he resigned.

This time around, while Senator Ishaq Dar has been scrupulously burning the midnight oil at the finance ministry, he remains distracted by ‘larger’ political issues. The result? Crucial decisions are being delayed, such as the finalisation of the terms of the deal to borrow around $600 million from banks. If this money had come through by now, it would have bolstered forex reserves — and confidence — at a vital time.

In addition, according to unconfirmed reports from insiders, the finance minister is positioned at the central node for many other crucial decisions ranging from privatisation to appointment of key personnel that pertain to other ministries. According to this version, his frequent absence from the country is creating a backlog of decision-making that may delay the inflow of privatisation receipts or the auction of 3G licences.

Whatever the truth on this count, the finance minister certainly needs to play a far bigger — indeed central — role in one critical area where he has not done so as yet. This is the issue of building a wider coalition within parliament on economic reform. It is absolutely crucial that parliament understands the need for reform, legislates accordingly and takes ownership. Logically, it is the country’s finance minister that has to take the role of stewardship on this front.

Another important stakeholder in terms of coalition-building for structural reform is the business community. Keeping them informed and bringing them on board are crucial for any success on this front.

Two channels of regular communication with the business community which Shaukat Tarin used as finance minister were found to be very effective. Apart from his frequent meetings with the business community across the country, he formed a formal group representing all the chambers of commerce and industry of Pakistan.

Called the Business Persons Council, it formally met once a month where the group heard from the finance minister and senior finance ministry officials on the state of the economy, the reform plan of the government, and the status of implementation of key measures.

From the business community’s side, the group heard first-hand about their problems especially those relating to the Federal Board of Revenue. This regular channel was extremely useful in disseminating the government’s proposed economic reform path, obtaining regular feedback and instilling a sense of confidence in the business community.

In conclusion, both the State Bank and the finance ministry need to become more proactive and nimble in their responses to navigate us through the period ahead.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.