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Rupee: short-term stability in sight

Updated December 24, 2018


The rupee seems to be on power diet these days. Authorities continue to feed it with foreign exchange pouring in from friendly nations.

How will this pan out after five years when this government completes its term? The nation is being kept clueless. We don’t know what we have promised to offer to our friendly countries in return for their generous financial support.

The United Arab Emirates said on Dec 21 that it would deposit $3 billion in the State Bank of Pakistan (SBP) “to support the financial and monetary policy of the country”. The Abu Dhabi Fund for Development said in a statement it would deposit this amount “in the coming days”.

Good news, indeed. It is expected to keep up the pro-rupee sentiments alive for some time. Once the promised $3bn actually comes in, it may even embolden our central bank to increase its support for the rupee.

It’s necessary for the government to reveal the exact nature of financial support from friendly countries

Earlier, Saudi Arabia poured in $2bn to help boost our foreign exchange reserves in two equal instalments in October and November. Another $1bn is expected in January out of the $3bn cash support the Gulf nation had promised in addition to a three-year $3bn deferred oil payments package.

UAE Crown Prince Muhammad bin Zayed and Saudi Crown Prince Mohammad bin Salman will visit Islamabad in January and February, respectively. Hopefully, both will announce mega investment plans.

SBP Governor Tariq Bajwa was not overly optimistic when he reportedly remarked on Dec 17 that taking the projected foreign exchange inflows into account, the pressure on the rupee would soon ease off.

But as we enter 2019, fundamental challenges of the external account remain. Given the quantum and timing of financial support from Saudi Arabia, United Arab Emirates and promised- but-not-quantified help from China, managing exchange rates may not be as difficult as it was in 2018. China assured Pakistan in November that it would help Islamabad fix the balance-of-payments issue.

In the week ending on Dec 14, Pakistan received the second instalment of $1bn from Saudi Arabia out of the $3bn promised package. This lifted the sagging foreign exchange reserves of our central bank to $8bn from $7.2bn a week earlier. Even at this level, the reserves are not enough to cover even two months of our merchandise imports. Less than three months of coverage is considered a sign of inadequacy of reserves.

In less than six months of this fiscal year, the rupee has lost 14.4pc value against the dollar. It came down to Rs138.95 a dollar from Rs121.50. In 2017-18, it saw 15.9pc depreciation as the current account deficit increased to $18bn from $12.6bn a year earlier. In the first five months of this fiscal year, the current account deficit came down to $6bn from $6.8bn a year ago.

This deficit will likely shrink further in coming months with an anticipated slowdown in imports and growth in overall exports and remittances.

So far, a substantial increase in services exports has saved the day while growth in merchandise exports has yet to pick up pace. As for remittances, inflows in five months through November have depicted a double-digit expansion, but the continuation of this trend is uncertain.

Some factors, like the recently announced additional incentives for banks and a jump in the export of manpower to Malaysia, fuel hopes. But a decline in the labour export to the Gulf region and widely anticipated lower economic growth in the United States in 2019 dampen optimism about remittances growth.

Meanwhile, 14.4pc depreciation in less than six months of this fiscal year following 15.9pc devaluation in 2017-18 continues to impact the economy with households and companies facing tough times.

Parents whose kids study in foreign countries or people who travel abroad for medical treatment or any other purpose now have to arrange 30pc more rupees to get as much dollars as they needed a year and a half ago. Industries importing raw materials from foreign sources and commercial importers engaged in the sales of foreign products are feeling the pinch of the rupee depreciation. This is affecting industrial and trading activities.

Going forward, most individuals are looking for an outright halt in rupee depreciation as it has unleashed inflation and businesses want to know when exactly the exchange rate will stabilise. The government is in no position to soothe the agitating nerves. As it is readying itself to enter into a new IMF bailout programme, the rupee may fall further. The world knows that the IMF and global fund managers still view our currency as overvalued. Besides, the current account deficit cannot be reduced or the central bank’s reserves cannot be boosted overnight.

So no one in the government or at the SBP can guarantee sustainable stability in exchange rates in the medium term as that depends on real net foreign exchange inflows. Short-term stability, however, seems possible now with huge financial support coming in from friendly countries.

Sustainable stability in exchange rates can only be achieved with improvements in the current account balance through non-debt–creating foreign exchange inflows: exports, remittances and foreign direct investment. Even if the government manages to secure an IMF bailout package after meeting some tough pre-conditions, like further depreciation, more interest rate tightening, broader tax reforms and steeper cuts in energy subsidies and fiscal deficit, it will only add up to an already large amount of external debts.

Build-up in external debts regardless of their sources means a greater need for foreign exchange for future debt servicing. This means increased pressure on exchange rates and smaller fiscal room for development spending particularly if the rupee loses its worth, pushing up the local currency cost of external debt servicing.

It’s necessary for the government to reveal the exact nature of financial support from friendly countries. Unless a nation knows on what terms and conditions it is getting foreign funding and how the country will fulfil them, its markets cannot have full confidence in any short-term stability in exchange rates.

Published in Dawn, The Business and Finance Weekly, December 24th, 2018