The State Bank of Pakistan’s (SBP) decision to reintroduce market-driven exchange rates from Jan 26 has started paying off dividends. After experiencing a massive, quick depreciation of 19.8 per cent value against the US dollar between Jan 26 and Feb 3, the rupee recovered 2.6pc of its lost value during the week ended on Feb 10.

On that day it closed in the interbank market at Rs269.28 to a greenback, up from Rs276.57 on Feb 3 but still far lower than Rs230.89 as of Jan 25 — its last trading day under a range-bound managed exchange rate regime.

The recent gains in the rupee are primarily owing to the selling of dollars by currency hoarders and some effective checks on the massive smuggling of the greenback to Afghanistan. This temporary rupee appreciation is a healthy development as it will provide much-needed support to sagging exports and will also lessen, to some extent, the rupee cost of external debt repayments.

But Pakistan’s forex crisis is so deep that it may take years to achieve stability in the external sector. The central bank’s forex reserves of $2.917 billion (as of Feb 3) provide import cover of fewer than three weeks against the standard minimum of three months. Even total forex reserves of $8.54bn (including SBP’s and commercial banks’ reserves) can barely meet the regular import bill of one and a half months.

If the country wants to avoid staying in the debt trap, it needs to restructure three key areas: energy, exports and labour productivity

Meanwhile, full-scale regular imports are yet to start. Banks are entertaining the import letters of credit (LC) of only strategically crucial petroleum products and food and medicine — and that, too, in a limited way.

The last tranche of $1.1bn of a $7bn stalled International Monetary Fund (IMF) loan is expected to come towards the end of this month or in March. This should set the stage for securing another, larger IMF loan (after June this year), besides paving the way for more forex inflows from other international financial institutions, foreign corporate investors, foreign commercial banks and friendly countries.

But the IMF’s last loan tranche will come (and Pakistan will be able to request another IMF loan) only if the country makes progress in key areas of reforms — withdrawal of subsidies from electricity and gas, increase in general sales tax, bringing agriculture, real estate and wholesale and retail trade under wider tax nets, slashing of the government expenses, privatisation/liquidation of some Public Sector Enterprises and introduction of a mechanism to monitor wealth accumulation by civil servants.

Doing all this requires strong, dependable assurance from the state of Pakistan — not just by the federal government. To make that happen, Pakistan needs to decide quickly whether the next general elections will be held on time and put to rest all speculations about extending the tenure of the current regime. This will become clear within the next few weeks, hopefully.

Thanks to massive curbs on imports amidst the forex crisis, Pakistan’s trade deficit is down 32pc now — from $28.6bn in July-Jan 2021-22 to $19.6bn in July-Jan 2022-23. But once curbs on imports are eased (after the release of the last tranche of the IMF loan), it will be too difficult to contain it further, more so because prospects of export growth remain dim in the short term. Between July 2022 and Jan 2023, exports were down more than 7pc to $16.47bn from $17.74bn in the same period of the last fiscal year.

Even if the trade deficit keeps growing at its current pace, it cannot be financed fully by home remittances that are also on the decline.

Monthly remittances averaged $2.342bn during July-Dec 2022 against an average monthly trade deficit of $2.831bn, figures from the central bank and Pakistan Bureau of Statistics show. This means Pakistan will have to rely on further external borrowings to keep its external economy afloat and avoid sovereign default — at least in the short run.

If the country wants to avoid staying in the debt trap, it needs to undertake homegrown reforms at least in three key areas — energy, exports and labour productivity.

Without ensuring that the circular debt of the energy sector is reduced to a manageable level, the fiscal cushion needed for minimising external debt cannot be achieved. This means the energy reforms should achieve two basic objectives: reduction in circular debt and availability of enough gas and electricity in the country to keep the wheels of industry moving.

But this alone will not help. We need to simultaneously reform the entire export sector. Here again, the main objectives must be (1) diversification in both export base and export destinations (2) enhancement of market competitiveness of export industries and (3) acceleration of IT and IT-enabled services.

None of these three objectives can be obtained without increasing labour productivity. So, initiating a separate set of reforms in this area seems logical. But these crucial reforms can be undertaken only in a stable political environment. How and when Pakistan will achieve the required political stability remains a million-dollar question. Let’s hope for the best.

Published in Dawn, The Business and Finance Weekly, February 13th, 2023