When the Federal Reserve (Fed) chose to go for the third consecutive interest rate hike on September 21 to contain inflation running at a decade-high (8.3 per cent in August), stocks and bonds markets around the world got nervous. The Fed’s move, followed by Russian President Vladimir Putin’s announcement regarding escalation in war with Ukraine, pushed an already soaring US dollar to a 20-year high.
Major currencies, including the euro, pound sterling and Japanese yen, all tanked. The Bank of Japan had to intervene in the forex market for the first time since 1998 to save the yen from falling to more humiliating lows. Chinese yuan also suffered nominally, and the Indian rupee plunged to a new lifetime low. That prompted the Reserve Bank of India to burn some forex reserves to support INR.
Forex markets across the world had started pricing in a rate hike by the Fed ahead of it’s September decision to raise the policy rate by 75 basis points. The currencies of many countries had already been on a downward slope — the same happened in Pakistan.
Pak rupee, already under pressure due to the forex crunch in the country, continued falling from one low level to another throughout the week ending on September 22 and hit a new all-time low in the process. During the week, the Pakistani rupee lost about 1.19pc value against the greenback. This brought the total loss the rupee suffered in three weeks of September to 9.55pc.
Further monetary tightening amidst phasing out interest rate subsidies on the Fund’s demand will increase the cost of production, more so due to the supply chain disruptions created by the floods
Since the beginning of 2022, the rupee has lost 34.5pc value, partly reflecting the impact of political uncertainty just before and after the ouster of then Prime Minister Imran Khan on April 7 and the 17pc gain in the US Dollar Index so far this year. The index measures the greenback’s strength against six major currencies of the world — the euro, British pound, Japanese yen, Canadian dollar, Swiss franc and Swedish krona.
Weak fundamentals of Pakistan’s external sector also have been weighing on its exchange rate. And an estimated $30 billion loss to the country’s economy due to the recent floods have further weakened these fundamentals.
Exports are growing but much slower than required, and volumetric gains are just too small. As a result, imports are down nominally but still more than double the exports. Many expect that imports will shrink considerably during this fiscal year due to far slower economic growth than projected earlier.
But the post-flood imports of food, medicines and relief goods may partly compensate for the possible reduction in imports due to slower GDP expansion. Home remittances have started falling (down 3.2pc in July-Aug 2022 from July-Aug 2021) due to the high base effect and challenging economic conditions in the Pakistani diaspora host countries.
There is little appetite for FDI since political uncertainty is high, long-term growth prospects are cloudy and chances of matching local investment are dim
Foreign direct investment is drying up. Global companies have little appetite for investing in Pakistan where political uncertainty is high, long-term growth prospects are cloudy and chances of matching local investment are dim, particularly after the 2022 flash floods.
Balance of payments needs will have to be met in the short term through the support of other countries. But aid and grants for flood victims are not flowing at the desired pace. Moreover, all major economies are braving their own post-pandemic challenges that grew fiercer after the Russia-Ukraine war and have now compounded due to continuous and sizable interest rate hikes by the US. Since the Fed has already hinted that its restrictive monetary policy may prolong, economists worldwide are predicting a global recession hitting the world in 2023.
In Pakistan, the government is projecting just 2pc economic growth during the current fiscal year ending in June 2023 against the pre-flood initial target of 5pc. This estimated loss of 3 percentage points in GDP growth would render at least 3m more people jobless. The government fears that headline inflation in this fiscal year may end at 27pc.
The State Bank of Pakistan (SBP) has been tightening interest rates since November last year to curb inflationary pressure — without much success. Business lobbies, including the apex Federation of Pakistan Chambers of Commerce & Industry, have warned that a further rise in interest rate may prove counterproductive.
So, what if the central bank applies brakes on monetary tightening or at least doesn’t go for big rate hikes? The rupee will continue to plummet, and the country may find it too difficult to meet its external debt servicing obligations. That is where creditor countries have a responsibility. Since Pakistan’s floods are a direct result of climate change brought about by the reckless industrialisation of advanced economies, they must start offering a debt moratorium to Pakistan and even go for debt-climate swaps, as the UN General Secretary has already proposed.
Otherwise, Pakistan will be in big trouble. The output of big industries in Pakistan is already down 16.5pc in July compared to June and 1.4pc lower than in July last year. Further monetary tightening amidst phasing out interest rate subsidies on the International Monetary Fund’s demand would increase the cost of production, more so due to the supply chain disruptions created by the floods.
That plus the rupee’s ongoing depreciation may produce cost-push inflation even amidst a post-floods lower aggregate demand. The need for further monetary tightening to prop up the rupee can be limited if Islamabad does not have to worry about external debt repayments at least during this fiscal year.
These repayments are the principal reason behind the falling forex reserves of the country despite the reduction in its current account deficit. The deficit in July-August 2022 stood at $1.918bn, down from $2.374 in July-August 2021. However, forex reserves held by the SBP shrank to $8.346bn as of September 16 from $9.816bn at the end of June, primarily due to debt repayments.
Published in Dawn, The Business and Finance Weekly, September 26th, 2022