Will dollar inflows improve market sentiments?

Updated February 04, 2019


It is time for the international community to take a fresh look at the IMF’s exchange rate policy.— File
It is time for the international community to take a fresh look at the IMF’s exchange rate policy.— File

ON Jan 23, Fitch Solutions said in the coming months the State Bank of Pakistan is expected to devalue the rupee again because of depreciatory pressures on the national unit from weakening external finances.

Earlier on Dec 27, State Bank Governor Tariq Bajwa had told reporters in Lahore ‘you will see market sentiments will improve and pressure will dissipate from the rupee once dollars start flowing in from friendly countries.’

Pakistan has received the final tranche of the $3 billion pledged by Saudi Arabia on Jan 24 and first of the three equal instalments of $1bn from UAE. The remaining $2bn from UAE is expected soon.

In his post-budget conference Finance Minister Asad Umar had revealed that a financing deal with China was ‘a few days away’. Meanwhile, to shore up dollar reserves he is also banking on the Pakistan Banao Certificates for subscription by overseas Pakistanis.

Going by official pronouncements the dollar inflows from a variety of sources may ease the pressure on the rupee for a short while.

It is time for the international community to take a fresh look at the IMF’s exchange rate policy

Addressing the Lahore Chamber of Commerce Mr Umar said the government wanted to finalise its negotiations with the International Monetary Fund (IMF) ‘sooner than later’ as the ‘gap’ in talks between the two sides had ‘significantly reduced in recent weeks’.

He hastened to add that the size of the IMF loan did not matter as much as ‘we need this programme for obtaining funding from other multilateral lenders.’

Apart from market sentiments, Mr Bajwa also pointed out that the movement of dollar and rupee depends on fundamentals of the economy. While market sentiments can temporarily be improved by foreign debt inflows, rebalancing of the economy on a sound basis will take much longer.

With the country piling up debt, devaluation may raise more problems than it solves.

Dr Farukh Saleem says during their five-year tenures, PPP borrowed Rs5bn a day and PML-N an average of Rs7.7bn every day respectively. In the past 5-months the PTI government has borrowed Rs15bn a day. He estimates that during FY2019 the PTI-government may be forced to pay 50 per cent of the Federal Board of Revenue (FBR) tax collection on debt servicing.

On the other hand, the cash-strapped PTI government had to reduce duties on imported raw materials whose prices had surged following 30pc devaluation in just one year despite subsidies provided for export-oriented industries. Similarly, the import of machinery and plants, made costlier by a stronger dollar, has been declared duty-free. This means loss of revenue.

A major problem in exchange rate is a strong dollar. “When interest rates rise in the US and not elsewhere the dollar strengthens,” says The Economist and adds: “That makes it harder for emerging markets to repay their debts. Falling currencies create trade tensions which may lead to competitive devaluations.”

The latest batch of data (Big Mac index based on purchasing power parity) show almost every currency is undervalued against the dollar. “More startling is the fact that ‘the greenback itself looks stronger, relative to its fundamentals, than in any time in three decades,” it concludes.

With debts emerging as a major problem worldwide, devaluation is being challenged in its heartland.

Immediately after taking over as new chief economist at IMF in October last year Gita Gopinath, a recognised unorthodox international expert on forex regime said: “The expectation that a weaker currency for a non-US economy is good for a country does not line up with facts.”

Elaborating on her findings, for example, she maintained that a weaker rupee is highly inflationary for India, has no significant impact on its exports and has a negligible impact on imports. On the other hand, a weaker dollar has very little effect on inflation in the US, has an expansionary effect on exports and has negligible impact on imports.

She argues that in the prevailing ‘dominant currency paradigm the strength of the greenback drives trade flows and prices ...Floating currencies therefore provide less of a cushion.’

The appointment of an IMF chief economist who holds views contrary to those long held by the Fund’s shareholders is a significant departure from the past Fund’s employment policy.

It may take some time before Ms Gopinath’s views are given serious consideration by the IMF Board of Directors. But Pakistan can build its case with the Fund by seeking support from her views.

Despite the continuing rupee depreciation since the early 1970s, imports have continued to outpace exports at an accelerated pace and Pakistan’s Terms of Trade (TOR) have declined.

TOR is the ratio of a country’s export price index to import price index multiplied by 100. Taking FY1990-91 as the base year, the TOR fell from 58.76 in the second quarter to 57.06 in the fourth quarter of FY2017-18. Foreign importers can buy cheaper, more Pakistani goods for a dollar, resulting in transfer of resources abroad.

The value of a currency is officially determined by its Real Effective Exchange Rate (REER) which is the weighted average of a country’s currency in relation to an index or basket of other countries adjusted for the effects of inflation.

Currency experts maintain that in the long term the REER moves closer to the purchasing power parity (PPP is a fair value benchmark) of their corresponding currencies.

This is not happening in Pakistan’s case as the gap between its two exchange rates, determined differently, are widening. According to World Atlas Data, Pakistan’s GDP, when measured by purchasing power parity was $1 trillion in 2017 as against below $300bn when calculated at REER rates.

And to beat back speculative currency trading which has nothing to do with either REER or PPP central banks are required to maintain huge foreign exchange reserves. It is time for the international community to take a fresh look at the IMF’s exchange rate policy.


Published in Dawn, The Business and Finance Weekly, February 4th, 2019