KARACHI, Feb 17: Pakistan’s trade deficit increased to roughly $6.5 billion in the first seven months (July-January 2005-06) of the current fiscal year. This is even larger than $6.2 billion deficit seen in the entire fiscal year 2004-05. The pace with which trade deficit is rising during the current fiscal year indicates that at the end of the year it will touch an all-time high of $10 billion.

That naturally would also expand current account deficit. The current account deficit already reached $2.9 billion in the first half of this fiscal year, exceeding the deficit of $1.6 billion seen in the entire fiscal year 2004-05.

Sources at the ministry of finance say if the trade deficit reaches $10 billion, the current account deficit would touch an all-time high of $6 billion. But they hope that the financial account of the country will perform better than expected.

During the first half of this fiscal year, Pakistan’s financial account posted a surplus of about $2.5 billion. That was why despite a huge current account deficit of $2.9 billion, the country’s overall balance of payments (BOP) showed a nominal deficit of $290 million only.

But as the trade deficit is growing fast, it seems that in the second half of the current fiscal year it would be difficult for Pakistan to keep its BOP deficit at a low level despite a build-up in the financial account.

In that event, foreign exchange reserves of the country will decline and the extent to which it will fall will depend chiefly on the size of the BOP deficit. Pakistan’s liquid foreign exchange reserves have declined by 9.5 per cent or $1.203 billion so far during this fiscal year, falling from $12.623 billion at end-June 2005 to about $11.421 billion on February 1. What is important to note is that between July 1, 2005 and February 11, 2006, the reserves held by the central bank has declined by $774 million — from $9.791 billion to $9.017 billion.

But despite this much fall in foreign exchange reserves, and despite a deteriorating current account deficit, the rupee remains stable — thanks to the central bank’s intervention in the foreign exchange market. The rupee lost only 0.4 per cent of its value against the US dollar in the inter-bank market so far during this fiscal year, falling to 59.93 on February 17, 2006 from $59.67 on June 30, 2005.

Since November 2004, the SBP has been selling dollars to banksto finance oil import bills to avoid undue pressure on the rupee and this practice still continues. That the SBP will continue this practice at least till the end of this fiscal year is evident from its monetary policy statement for January-June 2006. The statement released last month said that “the SBP is expected to remain an active player in the foreign exchange market to ensure effective monetary and exchange rate management,” implying that it will continue to sell dollars into the inter-bank market for financing oil and commodities imports. The central bank said in its policy statement that it sold $1.4 billion for financing imports of oil and imports of commodities (like fertilizers and wheat by official agencies) during July-December 2005.

Now, as the foreign exchange reserves have started falling fast and there is a limit to which the central bank would allow them to fall further, the rupee would seemingly come under pressure in the remaining part of this fiscal year. The import coverage of the foreign exchange reserves would be more important to look at. At the present level, the foreign exchange reserves are enough only to cover five months of imports. If this ratio falls, and chances are it would, in the coming months, then the SBP may be constrained to minimize its dollar selling in the inter-bank market.