WILL our exchange rate woes ever end? Is there a remedy?
Each upward movement of the rupee value of the greenback causes anguish. But why do we consider these depreciations so dreadful?
We, paradoxically, seek a remedy for a phenomenon which itself is a remedy for several of our economic woes.
Remedies are meant to cure diseases. But when a person has met with a serious accident, remedies take a long time to heal the wounds. Economic remedies are different from medical treatments. There are no quick fixes — like taking Panadol to treat a simple headache. Economic ills are more like chronic diseases, for example, migraines whose cure requires patience and multiple treatments.
External negative shocks to the economy resemble serious accidents as opposed to positive shocks which are like blessings. Sometimes negative shocks are triggered by natural disasters like earthquakes or floods, which result in the loss of output and an increase in prices. At other times, these result from global recessions or conflicts.
The current distressful situation in our country is a combination of external commodity price shocks, an internally grown cyclical balance-of-payments crisis worsened by this shock, an internal political crisis of our own doing and a perennial fiscal crisis. This near-deadly combination, together with Fitch’s downgrading of Pakistan’s rating after the IMF staff-level agreement, and more recently the S&P downgrade, has made financial markets extremely jittery. This confluence of events has prevented even good news on the IMF front from calming our financial markets, which had always reacted positively to such agreements previously.
These factors have made our financial markets unable to clearly distinguish between normal and jittery reactions. One may see the markets as overreacting to this complex situation. This is a new situation and markets also learn from experience. Consequently, the conventional doses of economic remedies have become weak in the eyes of the market. High doses of depreciation and inflation have, therefore, emerged to heal the shock and crises-afflicted economy.
A positive aspect is that we have already seen a partial correction in the exchange rate a few days earlier, after a comforting announcement by the IMF that Pakistan had taken all the required actions for the release of tranche.
The political crisis is preventing the economy from healing through normal doses of price increase.
Some may also argue that the markets have not overreacted. The exchange rate woes are interwoven with too many import payments chased by too few exports. The dollar value of petroleum imports, even when its quantum is stagnant, rises dramatically with the rise in international oil prices.
According to State Bank data, the FY22 petroleum imports have risen to $18.7 billion from $9.7bn last year representing a hefty growth of 92.8 per cent. This has led our FY22 total import of goods and services to rise to $84.2bn from $62.7bn last year, with a growth rate of 34.3pc. With the FY22 exports of goods and services increasing to $39.4bn from $31.6bn, the intense pressure on trade and services account is obvious. The FY22 deficit on trade and the services account has increased to $44.8bn from $31.2bn last year, representing a deterioration of $13.6bn.
One perplexing factor that affected the exchange rate is the extremely high value of petroleum imports in June 2022 — $2.9bn compared to only $1.4bn in May. Except for June, per month petroleum imports were valued at only $1.4bn. It is puzzling that this value is more than twice the values observed in earlier months.
This mystery can only be solved by breaking down the values in relation to the quantity of petroleum products and the corresponding import prices. This data will come after a couple of months.
One possible cause are the higher import prices when petroleum products were booked a couple of months ago and their higher value payments struck after approximately two months. Another possibility is that a larger quantum was imported in June.
While the imports in July were less than the imports in June, outflows on account of disinvestments of T-bills and other financial assets by non-residents added to the scarcity of dollars. It is thanks to workers’ remittances of $31.2bn in FY22 that our current account deficit at $17.4bn is much smaller than the trade deficit.
However, this deficit is far larger than the FY21 current account deficit of only $2.8bn. For many analysts, like those sitting in rating agencies, this itself is reason enough for the large depreciations observed so far. In addition, the current account deficit of June was $2.3bn — 64pc higher than the May deficit. From this perspective, the exchange rate battering is a rational market outcome.
The fact that we are witnessing an unambiguous political crisis prevents our economy from healing through normal doses of price increase including the exchange rate. The delayed IMF board meeting has also caused the markets to panic. They seem to have forgotten about the IMF staff-level agreement.
For Pakistani authorities, the most difficult job is to convince the IMF about the sufficiency of measures already taken. Now that the Fund has lent a helping hand (after Gen Bajwa’s call to a US official) to calm the markets through its reassurance about the completion of all conditionalities leading to its board approval, the markets have heaved a sigh of relief and are likely to witness significantly reduced volatility. All of this indicates that the rupee might appreciate significantly after the receipt of the IMF tranche.
As stated above, the confluence of various crises together with political uncertainty has caused these market sentiments, which may continue even after the resumption of the IMF programme. The credibility of the present government has further weakened after its unwise criticism of the recent Supreme Court decision which democratically installed a PTI government in Punjab.
The only prudent course of action for the federal government is to announce a date for general election free from generals and other non-constitutional influences. A credible interim government will go a long way in reducing political uncertainty and pave the way to establish the democratic writ of Pakistan’s citizens. This is the only option to lessen exchange rate and other economic woes.
The writer is a former deputy governor of the State Bank of Pakistan.
Published in Dawn, August 6th, 2022