NationalVOLUME 17 ISSUE # 3

The challenge of creeping devaluation

Due to a surge in demand for the US dollar to pay for imports, the Pakistani rupee has come under increased pressure over the last few weeks. According to media reports, the rupee is now Asia’s worst-performing currency, compared to its standing as the world’s top performer six months ago. It hit a 13-month low of Rs166.98 against the US dollar in the interbank market in the first week of September.

The worsening trend was noted as early as May when it became clear that the government wanted to opt out of the harsh International Monetary Fund (IMF) policies in favour of rapid growth before the next election. The pursuit of the growth policy has only put extra pressure on the external sector in the shape of drastic import growth without any significant improvement in exports. But the current growth spurt is being financed through expansionary fiscal and monetary policies and short-term expensive borrowings without implementing productivity reforms. Thus, the sustainability of the present boom remains uncertain amid fears of further deterioration in the fiscal and current account imbalances.

There are a number of factors behind the current exchange rate volatility, including a slowly rising trade deficit, creeping inflation and negative interest rates. The deteriorating market perception, among others, is caused by the country’s lack of capacity to finance its foreign payment obligations. It is worth mentioning here that the 144pc year-on-year surge in the trade deficit in August to the highest-ever level of Rs4.23b has put new pressure on the rupee.

The changes in the regional situation are also having an effect on Pakistan’s economy as Afghanistan has always traditionally relied on Pakistan and due to the recent discontinuation of US and European support the entire burden has fallen on Pakistan. The collapse of the Pakistan rupee against the US dollar has caused anxiety among traders and economists because of its far-reaching consequences, including a spurt in inflation.

In the midst of general worry, some market watchers are of the view that the dollar’s devaluation is just transitory because the dollar had risen to 169 rupees in the previous year and then fallen to 153 rupees. It is argued that if the rupee is not devalued as a condition of talks with the International Monetary Fund (IMF), the value of the Pakistan rupee against the US dollar will soon stabilize. However, this is contingent upon the government’s support to the State Bank of Pakistan (SBP)’s initiatives to strengthen our currency.

Another reason is that over the last 2-3 years, Pakistan has received a large number of external loans and also borrowed a significant amount from the bond market, which had increased the supply of dollars. Additionally, because of the Covid-19 situation, business activity has temporarily slowed down, and as a result, the dollar exchange rate dropped to Rs.153.

Also, the Financial Action Task Force (FATF) has yet to remove Pakistan from its grey list. Of the 27 conditions, Pakistan has complied with 26 of them, but they have introduced six additional sub-conditions with the remaining one. At the same time, there are rumors of dollars’ smuggling to Afghanistan.

As is clear, the world’s unwillingness to conduct business with the Taliban has forced Afghanistan to rely on Pakistan for everyday imports, which will further exacerbate the demand and the value of the dollar may increase in the coming days.

The only solution to the dire situation Pakistan faces is to give a fillip to exports, but export growth so far is not enough. Some quarters have underlined the need to impose an export emergency, impose tariffs on luxury imports and adjust the discount rate.

At the same time, drastic steps need to be taken to curb import pressure. This can be made by hiking the interest rate and imposing higher Petroleum Levy on petroleum products to check the demand. Another urgent requirement is to put a blanket ban on luxury imports, including cars and other consumer items. All in all, the challenge of creeping devaluation calls for remedial action on a wide front.

Some experts have called for an early upward adjustment in interest rates, measures to restrict unnecessary imports, market interventions to arrest further devaluation and steps to prevent the build-up of imported inflation and negative business sentiment. Traders booking dollars for future import payments at a higher premium or spread indicates an expectation of further rupee depreciation as the current account imbalance is anticipated to breach the State Bank of Pakistan’s projections of 2pc-3pc on account of stronger imports amid rebounding commodity and energy prices. The freeze on the International Monetary Fund (IMF) loan programme and the possible insecurity spillover from Afghanistan are also compounding economic uncertainties and keeping the rupee under pressure.

Expecting the painfully slow uptick in exports and remittances to save the growth momentum would be folly.