Is the rupee’s recovery sustainable?

Published June 27, 2022
A file photo of a person holding US dollar bills. — AFP/File
A file photo of a person holding US dollar bills. — AFP/File

Banks continue to brave forex liquidity crunch amidst rising demand for dollars. They are rationing foreign exchange to meet the most crucial demand originating from the most important among all clients.

As of 17th June, the State Bank of Pakistan (SBP) had only about $8.238 billion worth of forex reserves that covered just five weeks of import bills of goods. When the reserves are not enough to cover import bills for three months, they are considered inadequate. That sends a negative signal to the world, leads to panic forex buying at home and makes it too difficult for the central bank to defend the local currency. The local currency unit is under pressure — and loses value.

The rupee has been through this.

Back in August 2021, the SBP forex reserves were at their highest level of $20.074bn, enough to cover a little more than three months of goods’ imports. In September 2021, the reserves at $19.253bn still provided three months of import coverage. But from October 2021, the SBP reserves began falling, both in value as well as in terms of import cover.

The possible revival of IMF lending and eventually getting out of the FATF grey list should help set our external sector in order

The rupee came under pressure and lost 7.6 per cent value against the US dollar in the next five months and 10 days — between 1st November 2021 and 10th April 2022 (when Imran Khan was ousted from power).

The rupee began sliding too fast after the change of regime in Islamabad. In less than three months (between 11th April and 24th June) it lost more than 12.3pc value, coming down to 207.48 a US dollar on June 24 from 184.68 a dollar on April 10.

Fundamental reasons for the rupee’s weakening — widening trade and current account deficits, growing external debt servicing, low growth in total exports, stagnating foreign investment and signs of weaker growth in remittances were present even before the replacement PTI regime with a PML-N led rainbow coalition government.

The political uncertainty that followed, and country-wide charged protests that the ousted prime minister launched against the new setup, accelerated the rupee’s decline.

Delay in the revival of a stalled International Monetary Fund (IMF) loan programme brought about more uncertainty in forex markets amidst already deteriorating fundamentals of the external sector. Both the central bank’s forex reserves and the rupee remained on a constant downward slide. (The rupee touched an all-time low of 211.93 to the greenback on June 22 before making a handsome gain the very next day on news that Pakistan would get a $2.3bn loan from a consortium of Chinese banks within days).

Several international financial institutions including the World Bank and Asian Development Bank are waiting for the conclusion of the Pakistan-IMF deal to start project lending into the country

Regardless of this largely sentiment-driven recovery, concerns remain about the future health of the rupee. The SBP is maintaining market-driven exchange rates and even when its reserves grow large enough to embolden it to intervene in the forex market it would do so to smooth out extreme volatility — and not to keep the rupee artificially strong.

All the central bank can be expected to do is intervene in the market through short-term dollar-rupee swaps. This means it will buy back the dollars sold into the market within a specified period extending from a few days to a few weeks, as the situation may demand.

The SBP doesn’t want to remain a net seller of dollars into the market at the end of a quarter — and the IMF also doesn’t allow it. Future exchange rate movements, therefore, depend on when Pakistan gets $2.3bn from a consortium of Chinese banks. Other factors are how much more funds may come from China, Saudi Arabia and the UAE and how much growth remittances and exports show.

The rate at which imports decline, the movement of global fuel and food prices and how early the IMF revives its loan programme and the amount of its next tranche expected in July, all affect exchange rate fluctuations.

The revival of IMF lending is around the corner as Pakistan has met even the most painful condition of increasing fuel oil prices and ending even crucial subsidies on gas and electricity. Meanwhile, chances of getting out of the Financial Action Task Force (FATF) grey list have brightened.

The FATF recently acknowledged Pakistan’s compliance to the conditions set earlier for it to get out of the list and said its officials would visit the country to verify details of the compliance.

These two developments — the possible revival of IMF lending and eventually getting out of the FATF grey list by October — should help set our external sector in order.

Several international financial institutions including the World Bank and Asian Development Bank are waiting for the conclusion of the Pakistan-IMF deal to start project lending into the country. Friendly nations like China and Saudi Arabia have also reportedly communicated to the government that post-IMF deal they would place more state funds into SBP’s coffers or announce rolling over of already deposited funds.

Only after these things happen smoothly, Pakistan can expect a surge in foreign direct investment (FDI) that currently remains at about $2bn a year.

The economic team of the PML-N led government does realise now that a surge in FDI — as well as in foreign portfolio investments —should greatly help them shape up Pakistan’s external sector. Even the best efforts to boost goods and services exports would take no less than three years to cut the trade deficit significantly even if imports-containing tariffs and non-tariff measures continue alongside.

Remittances’ growth has already started slowing down and no dramatic volumetric increase in remittances can be expected unless the PML-N government gives e-voting rights to overseas Pakistanis. Let’s see!

Published in Dawn, The Business and Finance Weekly, June 27th, 2022

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