A former Governor of the State Bank of Pakistan (SBP) recently took the position in an article published in Business Recorder that this decision must rest with the central bank which, in turn, must carefully evaluate the net benefits of its determination. Sage advice however evidence suggests that while central banks the world over have begun to play a much more aggressive role in currency markets (due to market volatility sourced to global economic turmoil triggered by a fall in the international oil prices as well as Brexit) yet SBP remains subordinate to directives from the Ministry of Finance, irrespective of its autonomy on paper.
A former Secretary Finance, who worked with Dar during his current tenure, acknowledged in an article also published in BR that Pakistan today has lost the argument of keeping the rupee over valued which, he contended, was premised on a build-up of foreign exchange reserves. With reserves eroding today that argument no longer remains valid, he concluded.
The decision to over-value the rupee is sourced to the former Prime Minister Nawaz Sharif's flawed perception that a strong rupee reflects stable macroeconomic fundamentals and, on several occasions, he publicly directed Dar to ensure a stable and strong rupee. Dar followed these directives in letter and spirit however, unlike some other directions of the former Prime Minister, keeping the rupee artificially strong was widely believed to be in line with his own over-arching objective: to understate the rising external debt servicing in the budget.
Post-28 July Panama papers verdict Prime Minister Shahid Khaqan Abbasi began to chip away at Dar's pervasive influence under Nawaz Sharif, including taking over the chairmanship of the Economic Co-ordination Committee (ECC), and separating Statistics Division and Privatisation Commission from the Finance Ministry's administrative control. Abbasi also reversed some of Dar's decisions particularly that of releasing incentives to only those exporters who show a 10 percent increase after 30 June 2017. At the same time an increased prominence of Miftah Ismail, the newly appointed advisor to the Prime Minister on Finance, became evident. These factors have fuelled the market perception that the rupee would now be allowed to depreciate which, in turn, accounts for some disturbing forward actions by several key players in the foreign exchange market.
While the August 2017 figures as cited on the SBP website are still provisional yet market sources reveal that: (i) exporters fearing a depreciation are deferring remitting payments due to them for goods and services already delivered, (ii) importers have increased their orders to take advantage of a stronger rupee today, and (iii) the profiteering element of projecting an imminent erosion of the rupee in the foreseeable future can be considerable for banks (given that our banks handle around 75 to 80 percent of all foreign exchange transactions with money changers handling a mere 20 to 25 percent) especially given the wholesale rates they may enjoy.
To check speculation in the currency market that is placing further pressure on the value of the rupee Prime Minister Shahid Khaqan Abbasi publicly stated this week past that Dar would remain the country's finance minister till the next elections and remarked that Dar continues to work 12 hours a day. It is too soon to determine whether the Prime Minister has been successful in capping speculation however independent analysts have been challenging Dar's data as well as his understanding of economics for the past four and a quarter years and it is extremely doubtful if a savvy market player would be convinced that Dar's 12-hour-a-day focus on the economy would bear positive results.
Be that as it may, the exchange rate, economic theory dictates, is an outcome or symptom of the state of the economy and a function of five variables. Inflation and interest rates, both the domain of autonomous central banks, are used together to strengthen or weaken a currency. High inflation would imply a weakened currency which may prompt the central bank to raise interest rates to make the currency more attractive. Pakistan projected the rate of inflation for the current year at 6 percent (above the 2 to 2.5 percent that is considered to be positive to keep the economy well oiled) while inflation in our major trading partners remains much lower due to an ongoing recession with historically low interest rates. Interest rates were reduced as part of the policy of the Sharif administration to encourage private sector credit and therefore growth. So where are we at today? Inflation is high not only because of high taxes on inputs notably electricity and fuel with its negative impact on productivity and exports but also because the Dar-led Finance Ministry has raised domestic debt from 2.17 trillion rupees in 2013 to 5.37 trillion rupees in 2017 as per the Economic Survey 2016-17. Interest rates in Pakistan are higher than those prevalent in other countries which should have attracted foreign capital inflows but did not (apart from the China Pakistan Economic Corridor projects which are so far non-transparent) because of political uncertainty triggered by the Panama papers case, continued law and order concerns, and our low ranking in the ease of doing business by the World Bank. Incidentally the Dar-led Finance Ministry presented measures to ease doing business to the International Monetary Fund under the completed (2013-16) Extended Fund Facility programme but obviously to no avail as implementation remained weak.
Given these policy measures the rupee should have depreciated considerably and the SBP gives the real effective exchange rate in August 2017 at 122 rupees to the dollar while the actual market rate was 104 to 105 rupees per dollars.
Third factor that impacts on the currency rate is the current account deficit which as per SBP website rose from negative 4.8 billion dollars in July-June 2016 to a whopping 12 billion dollars in fiscal year 2017 (rise of 150 percent). The July-August figures for 2017 were 1.2 billion dollars while the comparable figure for the current year is negative 2.6 billion dollars (rise of 116 percent). In this context it is relevant to note that the major contributor to this rise is a decline in exports and a rise in imports of goods and services - in July-August 2017 negative 4.3 billion dollars and negative 6.7 billion dollars in 2018. Some exporters inexplicably argue that an overvalued rupee benefits them as their energy tariff is in dollars however those countries that meet their fuel needs from imports, including India, also determine their tariffs in dollars payable in local currency. However while Pakistan procures say LNG at a rate higher than India (perhaps because India is a larger buyer) yet additional charges in rupees make the differential in the delivered cost much wider. According to a study dated a few months ago, India's total delivered cost of LNG was 6.32 dollars per mmbtu while it was 11 dollars per mmbtu in Pakistan.
Portfolio investment during July-August was negative 98 million dollars in 2017 and positive 149 million dollars in the comparable period of 2018. However the stock market during the week past lost considerable value and this, many argue, is sourced to political instability as well as the capital gains tax imposed by Dar in the budget 2017-18.
Fourth factor impacting on currency is debt and liabilities (domestic and external) which as per the SBP reached 78.7 percent of GDP (provisional) in 2017, up from 77.6 percent in June 2016, which indicated a sizeable increase from 72.3 percent in June 2015. Short term debt procured from the external banking sector was zero in July-August 2017 though the yearly total was more than 4 billion dollars; while in July-August 2017-18 the total is already 216 million dollars.
SBP reserves are falling - from a high of 18.1 billion dollars in 2015-16 to 16.1 billion dollars in 2016-17 to 13.85 billion dollars by September 2017. Reserves, it was acknowledged by the IMF mission chief under the EFF are debt-enhancing, however if the country continues to support a strong rupee then it is highly likely that reliance on short term very expensive debt from the external commercial banking sector would increase further which, in turn, would compel any economic minister or advisor to hesitate to allow the rupee value to depreciate.
And finally, we have the element of political instability due to Nawaz Sharif's flawed conflicting narrative: PML-N projected as an opposition party and in conflict with the judiciary and the armed forces as a consequence of the Panama papers verdict while remaining in power in the centre, Punjab and Balochistan.
So would the government allow the rupee to depreciate given these many flawed policies that account for the widening of the difference between the actual rate and the real effective exchange rate? If the government takes the position that some depreciation is necessary to bolster exports and make imports less attractive (and one would hope that this is determined by economists rather than political appointees) then it must take the decision soon as speculative activity is worsening the situation. If it decides to let the status quo prevail then it would be placing the onus of going on yet another IMF programme on the next government with much more stringent conditions that would be a challenge for any elected government. Unfortunately Dar and his policies have left the country between a rock and a hard place.
Copyright Business Recorder, 2017