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IN case you haven’t noticed, the financial markets in Pakistan have hit choppy waters and nobody seems to be sure of the reason why. The dollar has been rising despite vigorous efforts by the State Bank to maintain its value in the open market. The stock market took a beating for a number of sessions, before posting a rise of 700 points finally in yesterday’s trade. Whether or not this bullish momentum is a suckers rally before the decline resumes will be known by today and tomorrow.
In any event, the near simultaneous declines in the exchange rate and the financial markets appear to have a common cause. Massive withdrawal of dollars by foreign investors is what stock market analysts are pointing towards. And the dollar itself has risen versus its peers in global exchanges, naturally placing pressure on the exchange rate here.
Both outcomes grow out of a common concern that the US Federal Reserve bank may be on the verge of reversing its years long policy of near zero interest rates. That decision is expected in mid December, and as per commentary in the global financial papers, it is almost a foregone conclusion that the rate hike will materialise, unless something massive intervenes between now and then.
It’s worth remembering that the large financial crises of the past arrived with little to no warning, at least none that was publically circulated.
In the days until then, analysts will be parsing the comments of Janet Yellen, the Federal Reserve Chair, who has two public speaking engagements, yesterday and today, both of which will be listened to closely to see if she continues to favour a rate hike, which she has been for a number of months now.
Meanwhile, another meeting with far-reaching consequences for Pakistan’s external sector is taking place in Vienna. Ministers from Opec are gathering for a meeting to discuss falling oil prices and make a decision on output. Oil prices have fallen by almost 40pc since June of this year, and thus far all signs are that Opec will not curtail supplies, so the declines are here to stay.
This state of affairs is sending powerfully contradictory signals through our economy. Low oil prices have caused the trade deficit to shrink, even as exports and foreign investment continue falling. Since the present-day level of the foreign exchange reserves is the more critical economic indicator for any government in Pakistan, the falls in the price of oil have bred a sense of complacency in the government.
The government of Pervez Musharraf in its last years was repeatedly warned that a growing current account deficit posed serious risks to the economy. Their stock response at the time would be that there is nothing to worry about because the capital account — which registers inflows of borrowed money — remains positive and is well capable of financing the yawning deficits on the current side.
All that changed when the commodity price spiral kicked in, and the great recession approached. Those record high reserves disappeared faster than Musharraf’s financial wizards could have foreseen, and the country was left in a financial mess equal to, if not larger than, what obtained when Musharraf first seized power in 1999.
This time too, the same complacency is at play, but under slightly modified circumstances. Low oil prices have lowered the oil import bill, granting some respite to the government, and breeding a sense that the record high reserves of the day can well weather us through the times to come.
On the other side, there is the possibility of a hike in US interest rates, the mere possibility of which has produced some gyrations in the exchange rate and the stock market. Thus far, the pressure on the exchange rate has been felt largely in the open market, with the interbank market relatively more stable. But reported comments of analysts paint a slightly more troubled picture, as they fear the uncertainties could infect the interbank market too.
The international environment that has played a very important role in bringing about the inflows of foreign exchange that fuel the government’s sense of complacency is about to change, and nobody is quite sure how drastic the change might be. A lot depends on the speed of the hikes that the Fed undertakes, and what accompanying message they send out about the future of interest rates there. A lot also depends on what sort of movements this action triggers in economies like China and India, where the former is still recovering from a strong bout of volatility it saw in its capital markets this summer.
Obviously there isn’t much the government can do to change the new circumstances emerging in the international economy. A stronger dollar will have ramifications for oil prices as well as financial markets, and both could produce consequences here. But at the very least, it would be reassuring to know whether stress tests have been performed on the reserves to gain some idea of what would happen if outflows were to accelerate in 2016. What would be the resultant impact on the exchange rate? How would the trade picture be impacted?
Thus far we are assured that all debt sustainability analyses performed on the economy show a healthy picture, but 2016 could be a year of some important changes. Despite the healthy level of the reserves, and the repeated assurances given that the external sector is improving, I for one remain unconvinced having seen repeated episodes in the past couple of decades where inflows quickly dried up, or outflows of a sort we hadn’t imagined suddenly materialised.
Perhaps it is overstating the case to imagine that something of that sort may happen in 2016. But it’s worth remembering that the large financial crises of the past arrived with little to no warning, at least none that was publically circulated, and were the result of developments that economists were not anticipating. Let’s hope the reassurances being given today hold up to the choppy waters of tomorrow.
The writer is a member of staff.
Twitter: @khurramhusain
Published in Dawn, December 3rd, 2015
