In May, consumer inflation rose to 13.8 per cent from 13.4pc in April. Meanwhile, the rupee which sank to an all-time low of 202 to a US dollar on May 26 gradually rose afterwards. It closed at 197.59 per dollar in the interbank market on June 2, recovering 2.2pc of its lost value.

The headline inflation at 13.8pc shows the stubbornness of inflationary pressure chiefly emanating from ongoing domestic consumption, high international food and fuel prices and a weaker rupee. The 20pc hike in local fuel oil prices effective May 27, followed by another substantial hike in prices (Rs30 per litre) effective June 3, is expected to push inflation further up in June and even afterwards.

The increase in fuel prices has already started pushing prices of almost everything up — from groceries to motorcycles and from cooked food to household electronics and from transport fares to doctors’ fees.

The regain in the rupee value vis-à-vis the US dollar could turn out to be temporary if it takes longer than expected to persuade the International Monetary Fund (IMF) to revive its stalled $6 billion lending programme and increase its size to $8bn.

Even if the IMF revives and enlarges its loan programme sometime this month and we receive a new loan tranche larger than the scheduled size of $900m, a lot more foreign exchange will be needed to keep the rupee stable

The big rise in domestic fuel oil prices has compounded the political problems of the new government. But the IMF wants the government to do more — increase electricity and gas tariffs, too, from July. Government officials say they will have to do that. This means that inflation may continue to remain in double digits in the July-September quarter and maybe in October-December as well.

This also means that the State Bank of Pakistan (SBP) will have to increase the interest rate further in July to signal to the markets its unwavering resolve that containing inflation is its top priority. (Between April 7 and May 23 the central bank has already raised its policy rate by 400bps to 13.75pc in two instalments).

Even though the central bank had started practising inflation-targeting earlier, officially inflation become its only top priority after the parliament granted it additional autonomy during the ousted government of Imran Khan. Inflation-targeting refers to a monetary policy framework wherein a central bank does not have to bother about economic growth and job creation while making policy decisions.

Expecting to contain inflation with tighter interest rates is fine when inflation is just a product of higher demand for goods and services. That is, of course, the case but only partly. Higher international fuel and food prices, the existence of a large parallel economy, persistent growth in the currency in circulation, the provincial governments’ failure to administer prices of essential goods and services, political interference in market regulation by the Competition Commission of Pakistan and a weaker rupee also continue to fuel inflation.

In such a scenario, interest rate tightening works only partly — and a time lag that is lengthier than usual. That is exactly what is happening now. And that is why inflation cannot be moderated easily and earnestly.

Despite having made a modest recovery, the rupee cannot stay strong for the reason that its weakness is rooted in structural issues in Pakistan’s external sector. Even if the IMF revives and enlarges its loan programme sometime this month and we receive a new loan tranche larger than the scheduled size of $900 million, a lot more foreign exchange will be needed to keep the rupee stable.

The SBP will have to further increase the interest rate in July to signal to the markets that containing inflation is its top priority

The National Accounts Committee is of the view that in the new fiscal year starting July the country’s net external financing need would be somewhere between $36bn-$37bn.

It is true that the revival of the IMF loan would pave the way for forex funds from other international financial institutions (IFI) including the World Bank and the Asian Development Bank. But development loans of these two and other IFIs are programme-based and trickle in slowly whereas Pakistan immediately needs large inflows of foreign exchange to attain forex reserves adequacy ie ensuring that SBP forex reserves are equal to at least three months of merchandise imports bills.

As of May 27, SBP had only $9.773bn worth of forex reserves — barely able to foot merchandise imports bill of one-and-a-half months. So what can be done immediately?

The government is working closely with Saudi Arabia and China to request both of them to place a few billion dollars each in SBP reserves. Riyadh has openly said it is considering extending the tenure of its $3bn already placed with SBP. But based on the ground realities of our external sector it would be naïve to expect that Saudi Arabia would not charge a higher rate of interest this time.

How soon Beijing may come forward to help and how much worth of deposit it could place in SBP coffers — and on what conditions also remain unknown. Even if Pakistan manages to get forex deposits from these two countries — or for that matter from any other friendly country as well — these are but quick fixes and are of little help in correcting structural weaknesses of our external sector.

Those weaknesses include the low base of export products, low productivity of workers, higher than the regional average cost of energy, inconsistent export promotion policies, no or very little focus on import substitution and the national habit of living beyond means that fuel consumerism and keep import bills high etc.

The previous PTI-led coalition government made visible efforts to boost remittances which grew from $23.1bn in 2019-20 to $29.4bn in 2020-21. Even in this fiscal year, the remittances have maintained a rising trend and based on 10 months’ data, one can expect that full-year remittances would cross $31bn.

Despite that our current account deficit stood at $13.779bn the first 10 months of this fiscal year. The SBP had to use $5.82bn from forex reserves to keep the country’s overall balance of payments in green, the latest official stats reveal. The external sector situation is alarming. Isn’t it?

Published in Dawn, The Business and Finance Weekly, June 6th, 2022