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Stabilising the exchange rate

July 29, 2013
- File Photo
- File Photo

Pressure on balance of payments eased in FY13, large-scale manufacturing grew faster than expected, and the agricultural sector performed generally well. And in the services sector, wholesale and retail businesses expanded.

On balance, the economy was seen moving in the right direction, though big challenges remained.

Now, in FY14, the economy is projected to pick up pace. And swift handling of the circular debt, proposed crackdown on power pilferers, revamping of state-owned enterprises, and efforts to cut non-development expenses and enhance tax revenues form the core of a visible economic revival plan.

Data pertaining to FY13 shows a broad-based improvement in external sector indicators, particularly in the second half of the year, with the current account deficit on the decline, foreign investment on the rise, and steady growth seen in exports and home remittances (see table).

The recent rupee downslide is, however, more real than speculative, as despite improvements in the above-mentioned external sector indicators, foreign exchange reserves have declined sharply in the last one year due to heavy external debt servicing.

“But as July stats for foreign investment, exports and home remittances pour in, the pressure on the rupee would somewhat ease off,” says a ministry of finance official, implying that forex inflows through these sources would moderately increase.

State Bank of Pakistan officials confide that much of the pressure on the rupee is originating from the flight of dollars, which is being facilitated by some unscrupulous foreign exchange companies. They believe that the central bank’s recent tightening of rules of business, including requiring exchange companies to identify the buyers of foreign exchange exceeding $2500, would soon bring in stability in exchange rates.

But bankers say that growing imports and the ongoing external debt servicing may continue to frustrate such efforts until Pakistan gets a new IMF loan by September.

And executives of exchange companies say that tougher rules imposed on them for buying and selling foreign exchange have rather paved the way for flight of dollars through informal channels. They cite this as a key reason for the 100-paisa fall in the open market value of the rupee within 24 hours after the issuance of new, stricter rules for exchange companies (from 103.50 per dollar last Tuesday to 104.50 per dollar last Wednesday).

“Can we sustain the latest surge in foreign investment is the key to determining the actual strength of our balance of payments,” says the head of a commercial bank, while pointing out that even if the country is able to secure a $6.3 billion new IMF loan, it would be used to retire old loans. “Indications so far are that foreign direct investment would keep rising even if portfolio investment begins to decline from a peak due to very high price-to-earning ratio of most of our blue chips.”

In FY13, the bulk of foreign direct investment — about one third — came into the food and food processing sector, which has also seen some local investment over the past few years due to better performance of major crops on the backs of higher support prices. In the manufacturing sector too, industries like sugar, wheat and grains milling, and edible oil manufacturing have seen increase in outputs for the same reason. In 11 months of FY13, these industries posted annualised growth of 9.3 per cent, 8.7 per cent and 10.4 per cent, respectively.

Among other important sectors of large-scale manufacturing where a big rise in outputs was seen, cement (5.4 per cent) and petroleum products (15.2 per cent) deserve special mention. The first helped the country earn more foreign exchange, and the other led to forex saving by reducing imports of refined fuel oils.

The fiscal imbalance, which has been the greatest worry of economic managers for several years in a row, remained very much in sight in FY13 as well, with the government borrowing heavily from both the central bank and commercial banks. And that, in turn, accelerated money supply, eroded the rupee value, and contributed to inflationary pressures. Supply-side improvements, however, kept inflation in check.

In the current fiscal year, the fiscal deficit is expected to remain lower than last year for several reasons — the most important being the government’s taking over the circular debt of Rs480 billion before the close of FY13. Besides this, the campaign launched to make recoveries from tax defaulters, the increase in general sales tax, phasing out of energy subsidies and other revenue-boosting measures announced in the FY14 budget are likely to mitigate fiscal woes this year.

In FY13, the Federal Board of Revenue failed to meet even the four-time downscaled target of Rs2,007 billion, and ended up collecting just Rs1,925 billion. This slippage not only created fiscal problems for the federal government, but also affected provinces in that it reduced the size of fund transfers to each province from the federal divisible pool.

Besides this, lower-than-targeted revenue generation fuelled growth of government’s domestic debt and increased the cost of debt servicing, thereby creating additional need for revenue generation.

“Now all eyes are set on the announcement of the new monetary policy in August. If the central bank leaves the policy rate unchanged, as being speculated in the market, keeping the cost of government’s domestic debt in check would be easy. But if it decides to increase the rate, it’d be problematic for the government,” says a financial analyst.