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Let the SBP do its job for a stable rupee

Updated December 10, 2018

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WHEN wisdom and impulsivity clash, wisdom should prevail.

Pakistan’s foreign exchange reserves fell to $7.5 billion at end-November, from $8.06bn a week earlier, after the interbank market consumed $1bn, received from Saudi Arabia before the month’s close, in imports and external debt servicing.

The plunge in rupee value on Nov 30 — to 139.06 per dollar from 133.99 a day before — was a true reflection of this fact. But since it clashed with the political interest of the government, markets saw a modest recovery later: the rupee closed at 138.89 to a dollar on Dec 7. Our forex reserves on Dec 7 will come into the public knowledge after a week.

With reserves that are enough to cover the import bill of just a little over a month and a half, the central bank cannot defend the rupee even if it so desires

Much has been said about how Prime Minister Imran Khan learnt about the rupee decline on the news and that Finance Minister Asad Umar knew about the move but that there was a communication gap between the finance ministry and the prime minister’s office.

Read more: Rupee sees plunge as volatility sweeps financial markets

Such things should not happen; they don’t help in maintaining the rupee’s health.

What is helpful is this: earn as much export dollars as possible; get as much in home remittances as possible; attract large chunks of foreign investment as early as possible; cut imports bills however you can — and let the central bank do its job freely with legitimate input from the monetary and fiscal policy coordination board, headed by the finance minister, and not from the prime minister’s office.

The board, by the way, met on Dec 7 and according to a Dawn report fiscal authorities conveyed to the SBP governor that there must be a mechanism of consultations with the government on exchange rates.

Can the autonomous SBP, where decisions on exchange and interest rates are taken by an independent monetary policy committee, accommodate such a demand? And if it does, will it not be compromising its autonomy? The answer seems pretty obvious.

With reserves that are enough to cover the import bill of just a little over a month and a half, the central bank cannot defend the rupee even if it so desires. It has to let the demand and supply determine the fair value of the local currency keeping its own role limited to save the market from extreme volatility on a daily basis for which it has appropriate tools.

The central bank knows this. That is why it lets the interbank market operate smoothly—in a manageable exchange rate band—and then allows an occasional depreciation when dollar demand becomes impossible to handle on the back of shallow forex reserves.

That such occasional exchange rate adjustments have lots of political implications is but a reality.

The government must accept the reality and move decisively towards what can be done to mitigate the underlying balance of payments problems and avoid responding to them impulsively.

When wisdom and impulsivity clash, wisdom prevails. Our own forex history bears this out.

The impulsivity of then finance minister Ishaq Dar clashed with wisdom on July 5, 2017 — the day the SBP let the rupee fall to 108.24 a dollar from 104.90 a day before.

Wisdom prevailed when on Dec 12 that year the rupee had to be brought down to 110.64 per dollar after being kept hostage to an artificial exchange rate band.

Since then, several downward adjustments have taken place — all in response to the growing dollar demand amidst low supply.

That the rupee is still overvalued is a fact the central bank itself admits and differs with the International Monetary Fund (IMF) only on the extent of the overvaluation.

In about a year, the rupee has become cheaper versus the dollar by Rs30.47, with its interbank market closing of 138.89 on Dec 7 this year from 108.42 on Dec 11 last year.

This decline in rupee value is still insufficient to acquire equilibrium in our exchange rates given the realities on ground.

Our July-Oct deficit of merchandise and services trade was $11.6bn; our current account deficit was $4.84bn; we used $1.6bn of already declining forex reserves to fill in the balance of payments gap; external debt servicing ate up $2.45bn in July-Sept and fiscal deficit that breeds the current account deficit was around Rs542bn or 1.4pc of GDP during this period.

Why wonder then that the rupee is falling? We have little forex reserves. Why wonder if a weaker rupee and a sizable fiscal deficit, put together, are pushing up inflation? And why wonder if the SBP continues to tighten interest rates to fight inflation— on Nov 30 it raised its key policy rate to 10pc for two months?

Prime Minister Imran Khan is willing to make a fresh start with the US after receiving President Trump’s letter seeking Pakistan’s help in the Afghan peace process. How soon and how efficiently the PTI government can handle the current forex crisis depends, to some extent, on whether it is able to reset ties with the US.

Much, however, depends on how soon we get a new loan from the IMF and how soon the promised financial assistance from China and the UAE materialise. Sources in the Ministry of Finance are expecting inflows from both countries before end-December or early January.

That is very crucial because getting an IMF loan approved from its board of directors in their January 15 meeting is not a certainty as Pakistan and the Fund are still busy sorting out some thorny issues.

Published in Dawn, The Business and Finance Weekly, December 10th, 2018