'Rupee's guardian angel': Will the new finance minister be able to fulfil all expectations tied to him?
The coalition government's move to replace Miftah Ismail with Ishaq Dar signals a paradigm shift in its economic management. The market believes — and the new finance minister has himself confirmed — that his top priority is strengthening the rupee, and then controlling inflation. Reactions to that statement have been mixed: some believe it will improve market sentiments, signs of which are already visible, while others fear it means going back to the strong rupee policy during his previous stint from 2013-17.
Whichever way opinion goes, one thing is clear: the new finance czar's performance is the most discussed topic in economic circles. Will he be able to stabilise the rupee, turn the economy around and control inflation? Why did he replace Ismail and what will he be doing differently?
First order of the day: improve public perception of economic performance
A volatile rupee has a significant political cost in Pakistan because the public interprets it as a sign of the government's poor economic performance. For most people, a depreciating rupee is an indicator of economic decline. It can cost a party their votes, and thus, their election. Undoubtedly, adhering to a market-determined exchange rate is a sound policy, but political priorities in a country like Pakistan push for an urgent show of performance. This is why the government needed to bring in someone who could give results on an urgent basis.
The rupee remained unstable even after the much-awaited revival of the International Monetary Fund (IMF) programme. Speculative pressures on the PKR refused to fade away. Not only was the rupee depreciating, it was doing so too fast. The fluctuations and weekly changes in trends were hurting its credibility.
On September 6, the rupee was trading at 233.5 per dollar in the open market against the interbank rate of 219 — a gap of Rs 14.5. The gap subsequently dropped, but from the wrong side. Instead of recovering in the open market, the rupee dropped in interbank trade to 239 per dollar on Sept 20, mainly due to continued speculative pressure in the open market, which was so strong that even the news of Saudi Arabia rolling over a $3 billion deposit did not stop the slide.
The market was in panic mode. Speculative buying increased. The pressures were causing the rupee to depreciate rapidly and inflation to increase. All this was negatively affecting the perception of the government's economic performance in the public's eyes.
With no more good news left to calm down the markets and turn sentiments positive, the government turned to its trusted economic manager. The new finance minister's previous tenure from 2013 to 2017 was marked by policy certainty and little investment volatility, which became the reason for his appointment yet again.
Rupee's guardian angel
The coalition government is putting all its faith in the new minister's ability to improve public confidence in its handling of the economy. Many expect that this will be done through the PML-N stalwart's defining policies, or Daronomics.
Previous finance minister Ismail's team was undoubtedly taking much-needed hard decisions linked to long-term structural reforms. But the government does not have a long time left to improve its image before the general elections. It needs an immediate revival of the economy. It has thus tied all its hopes to the new economic manager and expects him to navigate the country to more secure economic shores.
In his previous tenure, Dar kept the exchange rate stable at around Rs90 per dollar, even as some experts said the rupee was overvalued. It is believed that this time too, he will be able to stabilise the currency and bring certainty to monetary and investment markets. The rupee's deteriorating value had a lot to do with speculative buying of dollars and the market expects that Dar will be able to bring the rupee back to its actual worth.
It is also expected that he will be able to tackle economic issues such as inflation, which in recent times, has risen to decades high. Along with disruptions in supply chains and global commodity price hikes, the declining rupee was an important driver of inflation. So, if the new economic team can reduce the rupee's volatility, it may ease inflation to an extent.
Some new challenges this time
Will the new finance minister be able to deliver on expectations? The answer is mixed. He may be partly successful in arresting the rupee's fall — the PKR has gained Rs11.26 over the last six sessions. However, it has yet to be seen whether this recovery will be sustainable. When the rupee recovered previously, the gains were lost within a week or two, which highlighted the volatility of the exchange rate. In addition, the dollar has been strengthening internationally, reaching two-decade highs against some currencies.
But the odds in favour of him turning the economy around and controlling inflation in the short term are very low. There are several challenges that may make his job difficult. Contrary to the economic conditions during the previous PML-N government, the current one is in a race against time and the pressure is building ahead of the general elections next year.
Day-to-day firefighting has limited policymaking. Moreover, the PML-N is leading a coalition government which means policy decisions have to be more participatory and all parties need to be taken on board. Making and implementing decisions, thus, becomes a hard task amid the prevailing political instability in the country.
This year's devastating floods have caused widespread destruction and disrupted supply chains. As a result, food inflation has surged. Global food prices are also on the rise and will affect the economy, especially since Pakistan will rely on wheat and rice imports to stave off the effects of agricultural destruction. This will, in turn, have a negative impact on our balance of payments.
With an average inflation rate of around 25 per cent and an anticipated GDP growth of just 1-2pc in FY23, Pakistan is suffering from severe stagflation. The additional twin crises of balance of payments and political instability, coupled with the unprecedented monsoon rains, mean there will be a prolonged and worsening period of stagflation.
Worryingly, the country’s policy options to fight stagflation are very limited. Contractionary monetary and fiscal policies to correct the balance of payment crisis under the IMF programme — which requires raising the interest rate, cutting expenditures, erasing subsidies, and raising taxes — will continue to suppress economic growth on the one hand while the increase in the petroleum and energy prices under the programme for fiscal consolidation will continue to push inflation further up.
However, the new finance minister still has a much better environment than his predecessor did.
Read: Return of the 'Dar' ages
An easier environment
Unlike his predecessor, the new finance minister does not have to take politically tough but necessary decisions such as raising fuel prices by Rs100 per litre during the government's early days to ensure the IMF programme's revival.
When Ismail took charge, political instability and global oil prices were at their peak, the IMF programme was derailed, and there was an extreme credibility crunch due to the reversal of policies, particularly freezing prices in March by the PTI government. Development partners were not ready to give loans and even friendly countries linked deposits and loan extensions to the IMF programme’s continuation.
But now the country is back in the IMF programme, development partners and friendly countries are ready to listen and show support. Saudi Arabia has already extended its $3bn deposit for another year.
On the external front, the fear of recession is pushing commodity and oil prices downward. Brent crude and WTI crude are trading around $86 and $73 a barrel, respectively. In May both brent and WTO were trading around $115 a barrel. The reduction in global oil prices means there is less pressure on the balance of payments.
So, Dar is taking over with the economy in a much better state.
Editorial: Dar's plans
What the new finance chief shouldn't do
What the new finance minister can do is important, but what he should not do is even more so. There are at least three things he should avoid.
Populism on IMF and interest rate hikes
Populism around the rupee and interest rate must be avoided as it can jeopardise the IMF programme and undermine the State Bank of Pakistan's (SBP) autonomy. The previous government had brought the IMF programme to a halt by its populist policy of freezing fuel prices in March, which took the country near default.
The outgoing finance minister has done much-needed work and reforms to get the IMF programme back on track. These efforts must not be wasted by artificially fixing the currency price and asking the SBP in public gatherings to cut policy rates. The government must act on what the country committed, including a market-determined exchange rate.
Additionally, the new economic team must engage with the IMF to ease some tough conditions, particularly related to inflationary revenue sources. With a priority focus, the new finance minister, as he has already indicated, must sit with the IMF for relief in the ongoing programme.
As floods have washed out almost 10pc of last year's GDP, the revenue target must be revised accordingly. At the very least, the IMF should be convinced to cut it by 10pc, leading to a revenue target of Rs6,723 billion for FY23 instead of Rs7,470bn. The majority of the cut must be aimed at petroleum levy and electricity prices which will significantly ease inflationary pressure.
Fixing currency price by freezing impact of economic fundamentals
A market-based exchange rate functions only when changes are caused by market or economic fundamentals. If speculations or sentiments start to play a larger role or begin to influence currency deviation, the situation becomes very dangerous and has a negative effect on the effort to establish an efficient market-based exchange rate.
Efforts to get the rupee back its worth must not be confused with not letting economic changes pass on to the PKR and fixing the currency price. There are fears that the approach to stabilise the currency shall be the same as the one taken in 2013-2017, in which dollars were injected into the market and an artificial exchange rate was created.
This has a serious long-term impact on the economy, and hence should be avoided. The exchange rate is the price of currency and like any other prices, it is damaged if distorted.
Policies undermining the SBP's autonomy
While arresting the rupee’s fall, the new finance minister must work with the SBP as managing the exchange rate is a core responsibility of the central bank. A close collaboration between monetary and fiscal policy must be ensured. But any policies that bypass the SBP or compromise its autonomy must be avoided.
After the SBP Amendment Bill, 2021, which granted full autonomy to the central bank, it becomes the SBP's responsibility to come up with a mechanism or a framework to pre-empt speculative pressures on the rupee and make independent decisions about the policy rate.
The new finance minister must strengthen the SBP so that there is no perception of unduly intervention of the finance ministry in the SBP’s roles.