Prior to departure this Friday past the IMF mission remarked that "the transition to a market determined exchange rate has started to deliver positive results on the external balance....monetary policy is helping control inflation." This is perhaps a tacit acknowledgement that the market based exchange rate was targeted to reduce the current account deficit (with its impact on inflation not considered); while the claim that monetary policy is targeted to reduce inflation would certainly have baffled many as inflation is set to rise by the Fund's own projection of 13 percent for the current year (given that in August 2019 inflation was calculated at 10.50 percent as per the new base 2015-16 and 11.63 according to the old base year 2008).
What must be a source of serious concern is that the Pakistani side failed to highlight the fact that the rupee was already undervalued in the week ending 12 May 2019 when the staff level agreement was reached between the IMF team and the Pakistani economic team led by the Governor and the Advisor to the Prime Minister on Finance. The SBP table reproduced below shows NEER (nominal exchange rate) defined as the weighted average of bilateral nominal exchange rate of the rupee in terms of foreign currencies and REER (real effective exchange rate) defined as the weighted average of the nominal exchange rate, adjusted for inflation.
As clearly evident from the table the rupee was grossly over-valued during Ishaq Dar's tenure as the finance minister - with REER as high as 122.8 in January 2017. The SBP Governor at the time was, in spite of the autonomy granted on paper by Dar, operating under Dar's instructions. An an over-valued rupee was designed to understate Pakistan's rising external indebtedness through reducing the budgeted allocations to meet external debt obligations (interest on loans from bilaterals/multilaterals and foreign commercial banks and debt equity as well as repayments as and when due). Economic theory dictates that an over-valued rupee reduces exports due to loss of competitiveness and encourages imports as they become cheaper. The result: rising current account deficit.
In December 2017, subsequent to the visit of an IMF team Miftah Ismail, the then Finance, Revenue and Economic Affairs Adviser to the Prime Minister, depreciated the rupee by 5 percent and then again in March 2018 by 4.5 per cent or a total of 9.5 percent within four months. The objective: to contain the widening trade and current account deficits. The table shows that in December 2017 the REER declined from November's over valued 120.3 to 115.3 and in March from 109.2 to 107.8.
By October 2018 REER declined to 103, by November to 101 and effective December the REER was 97.6 or in other words the rupee was under-valued by a little over 2 percent and continued to be under-valued till April 2019 when the REER registered 98.5. The "prior" condition of the 12 May IMF staff level agreement, to adopt a market based exchange rate, promptly implemented by Baqir resulted in an engineered plummeting of the REER to 90.2 in June or the rupee was under-valued by 10 percent. It rose slightly to 91 in July and calculations by independent economists indicate that in August the rupee was over-valued by around 7 percent.
It is possible that Baqir, appointed Governor on 4 May 2019, did not have enough time to familiarize himself with the actual rupee value till the staff level agreement was reached, around seven days later, that would have enabled him to better negotiate with the Fund. To give Baqir the benefit of the doubt perhaps his intent to under-value the rupee may have stemmed from his desire to promote exports. Sadly, the rupee under-valuation has not fuelled exports significantly in dollar terms (ample evidence available for this till May 2019). Imports however have declined significantly (partly attributable to the rupee under valuation and partly to the completion of projects under the China Pakistan Economic Corridor) and together with the 3.2 billion dollar deferred oil facility that the Prime Minister procured from Saudi Arabia a good five months before Baqir was even being considered for the position, current account deficit has declined to 5.5 billion dollars in the first two months of the current year in comparison to the 7.5 billion dollars of the comparable period of the year before.
To conclude, the negotiating skills displayed by the SBP during negotiations with the Fund are reminiscent of the famous phrase from William Shakespeare's Hamlet attributed to Marcellus, a palace guard that "something is rotten in the state of Denmark."
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STATISTICS AND DATA WAREHOUSE DEPARTMENT
Nominal/Real Effective Exchange Rate Indices of Pak Rupees
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( Base 2010 = 100)
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Month Average NEER REER Percentage Change
over last Year
NEER REER
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100 100
Jun-14 84.6186 108.1043 -0.10 4.97
Jun-15 88.6289 117.0138 4.74 8.24
Jun-16 89.2890 117.3399 0.74 0.28
Jun-17 90.9981 121.0086 1.91 3.13
Jun-18 78.4221 107.4833 -13.82 -11.18
Jun-19 R 62.9212 90.2846 -19.77 -16.00
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Monthly Position Percentage Change
over last Month
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Jan-17 93.4178 122.8520 -0.31 -0.42
Feb-17 92.7121 122.0453 -0.76 -0.66
Mar-17 92.6922 122.7800 -0.02 0.60
Apr-17 92.3127 123.5133 -0.41 0.60
May-17 91.7347 122.4700 -0.63 -0.84
Jun-17 90.9981 121.0086 -0.80 -1.19
Jul-17 89.6733 119.6111 -1.46 -1.15
Aug-17 88.7770 118.2829 -1.00 -1.11
Sep-17 88.0179 117.6544 -0.86 -0.53
Oct-17 88.8910 119.5480 0.99 1.61
Nov-17 89.0541 120.2306 0.18 0.57
Dec-17 85.7316 115.3417 -3.73 -4.07
Jan-18 82.7452 111.0343 -3.48 -3.73
Feb-18 81.9776 109.2191 -0.93 -1.63
Mar-18 80.6127 107.8884 -1.66 -1.22
Apr-18 78.7223 107.1773 -2.35 -0.66
May-18 80.2699 109.7098 1.97 2.36
Jun-18 78.4221 107.4833 -2.30 -2.03
Jul-18 76.1841 104.6808 -2.85 -2.61
Aug-18 77.8719 106.7118 2.22 1.94
Sep-18 77.8306 106.0149 -0.05 -0.65
Oct-18 74.1638 103.1371 -4.71 -2.71
Nov-18 72.7696 101.4948 -1.88 -1.59
Dec-18 70.0615 97.4692 -3.72 -3.97
Jan-19 69.3716 97.6124 -0.98 0.15
Feb-19 69.2257 97.6775 -0.21 0.07
Mar-19 69.0250 98.6660 -0.29 1.01
Apr-19 68.2846 98.5519 -1.07 -0.12
May-19 66.9004 96.9998 -2.03 -1.57
Jun-19 R 62.9212 90.2846 -5.95 -6.92
Jul-19 P 61.9957 91.0072 -1.47 0.80
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