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Feeble rupee, IMF and rising inflation

Updated October 15, 2018

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A national debate has ensued on the pros and cons of keeping the economy under the watchful eyes of the IMF that leaves little room for a borrowing nation to pursue its own economic priorities. ─ File photo
A national debate has ensued on the pros and cons of keeping the economy under the watchful eyes of the IMF that leaves little room for a borrowing nation to pursue its own economic priorities. ─ File photo

After some dilly-dallying, the government is going to the International Monetary Fund (IMF). It wants to borrow at least $7.5 billion under a three-year programme to partly bridge a much larger gap between the country’s net inflows and outflows of foreign exchange.

Prime Minister Imran Khan says the gap during this fiscal year should be somewhere between $10bn and $12bn. But independent economists continue to offer far higher estimates.

A national debate has ensued on the pros and cons of keeping the economy under the watchful eyes of the IMF that leaves little room for a borrowing nation to pursue its own economic priorities. What has necessitated a reluctant return to the Fund is the fact that Pakistan, after accumulating huge external debts including from the Fund itself, finds their servicing difficult.

Mr Khan and his colleagues want to keep reminding the nation about the fact that the previous government had added the most to the stock of external debts ($35bn). The federal cabinet has now decided to set up a parliamentary panel to probe the surge in foreign debt in the past 10 years.

For many, this move is aimed at addressing public anger against the depreciation of the rupee last week that has started pushing up inflation, making life tougher for tens of millions of poor Pakistanis.

The government approached the IMF for a balance-of-payments bailout only after the rupee depreciation that many analysts saw as a prelude to the rescue lending by the Washington-based institution

On Oct 9, the State Bank of Pakistan (SBP) purposely let go of an informal dollar-rupee exchange rate band. At the end of the day, the rupee lost 7.54 per cent value in the largest-ever single-day depreciation and closed at Rs133.64, down from Rs124.27 a day before.

For ordinary Pakistanis, this came as a sudden shock. But banks and financial markets were expecting this: the only element of surprise was that the move came more than a week after the end of the first quarter on Sept 30.

The PTI government that took charge on Aug 18 had consistently hinted that it would prefer arranging multi-billion dollars from friendly countries instead of going to the IMF, although Finance Minister Asad Umar never ruled out this option. That friendly support didn’t come in the first quarter despite a precarious position of our external sector — a merchandise trade deficit of about $8.9bn within that quarter against the central bank’s foreign exchange reserves of just $8.3bn on Oct 5.

The government approached the IMF for a balance-of-payments bailout only after the rupee depreciation that many analysts saw as a prelude to the IMF’s rescue lending. Before that, a 1pc increase in the SBP’s key interest rate on Sept 28 also hinted that the government had made up its mind to go to the IMF.

Now the debate about the pros and cons of desperate borrowing from the IMF continues. Some points being raised are usual: IMF money means fiscal belt-tightening and tighter monetary policy that would slow down economic growth. It means more flexible exchange rates that will fuel inflation further. It means restructuring of state-owned organisations and ultimate privatisation of entities like Pakistan Steel Mills and Pakistan International Airlines that will cause joblessness and erode PTI’s political capital.

Opposition leaders say PTI leadership is long on promise, short on delivery.

They want to know why the government waited for 50 days to return to the IMF even though it knew that other options being exercised — crackdown on corruption — and being explored — support from friendly countries — could not help in the short run.

Amid this charged environment, banks and financial markets still seem a bit confused and are waiting for certainty. It was uncertainty-driven panic that triggered the Oct 8 stock market crash in which the KSE-100 Index fell 1,328 points, the biggest one-day decline in the last 15 months. It was uncertainty that a 7.5pc rupee decline led to the widening of the gap between interbank and open market exchange rates to Rs5 on that day. It is uncertainty that, combined with the rupee’s fall, is now fuelling inflation.

During the week ending on Oct 11, the sensitive price index, or inflation for the poor, shot up 6.52pc, three times faster than its 2.02pc increase in the week before. The government had increased energy prices even before making a formal request for the IMF bailout. Once the IMF approves lending, further price hikes are expected. “The rupee can fall a little more — by the end of this quarter or early next quarter— as the IMF believes our foreign exchange regime is rigid and the rupee overvalued,” says the treasurer of a large local bank.

“Uncertainty in markets may continue till the time we know the specifics of the IMF programme and the conditions attached to it,” says Arif Habib, former chairman of the stock exchange.

He says 50 days are not a long period for a new government to decide on a crucial matter like a return to the IMF, although he believes that an earlier decision could have minimised uncertainties.

“In fact, I believe that immediately after the end of the previous IMF programme in 2016, Pakistan should have sought another programme. Experience tells us that IMF programmes promote greater fiscal discipline and keep market uncertainties at bay,” he says.

A resumption of balance-of-payments support from the IMF will help remove uncertainty. But the external sector can improve only if exports and remittances continue to grow in double digits for a long time, imports remain static or fall and foreign direct and portfolio investments start coming in.

Published in Dawn, The Business and Finance Weekly, October 15th, 2018