ACHYUT MISHRA and ABHISHEK MISHRA
Pakistan rupee depreciated by 50% in Dec 2017-July 2019. With forex reserves left for one-and-a-half months of imports, Pakistan faces balance of payments crisis.
The Pakistan rupee has dropped to 160 against the dollar on the back of ballooning deficits and tough conditions imposed by the International Monetary Fund (IMF) for a $6-billion bailout to aid the nation’s ailing economy, among other factors.
The Pakistan rupee (PKR) has fallen 16 per cent since February, depreciating by 50 per cent between December 2017 and July 2019.
On 11 December 2017, approximately 105 PKR could have purchased $1. In 2018, the exchange rate increased to around 139 PKR per USD. Towards the end of June this year, this exchange rate peaked at about 163 PKR per USD.
A host of factors have contributed to this slide, including tensions with India in the wake of the 14 February Pulwama attack by the Pakistan-based Jaish-e-Mohammed (JeM) and New Delhi’s retaliation with the Balakot air strikes, which hurt sentiments in the currency markets.
With forex reserves sufficient to only service one-and-a-half months of imports, Pakistan is facing a balance of payments crisis, which occurs when a country’s imports exceed its exports and it doesn’t have sufficient capital inflows to finance the gap. This forces the country to deplete the nation’s forex reserves to bridge the deficit, known as current account deficit.
With the fiscal deficit — more expenditures than revenue — on the rise as well, Pakistan is in the midst of serious twin-deficit problem.
Pakistan’s GDP is expected to grow at around 3-3.3 per cent in the year ending June 2019, as against 5.5 per cent in the year-ago period. Inflation, measured by the consumer price index, is also on the rise.
In June 2019, it was around 9 per cent, as against 5 per cent in the year-ago period, according to State Bank of Pakistan data.
To add to the country’s woes, the trading community is rattled by the austerity measures introduced by the Imran Khan government in keeping with the IMF’s conditions for the recent $6 billion bailout, Pakistan’s 13th since the late 1980s.
The conditions included expanding the tax base — just about 1 per cent of Pakistanis reportedly pay tax — and cutting some preferential subsidies, while mandating the production of ID documents for purchases of over PKR 50,000 to cut tax evasion and traders’ resentment has manifested in backlash against the administration, including a nationwide strike last month.
Another condition was to end government intervention in fixing the exchange rate and let it be determined by the market.
Occasional interventions
Pakistan has been running a current account deficit for some time now. Between the financial years 2015 and 2017, its current account deficit increased from $3.12 billion to $12.49 billion.
In a market-driven freely-floating exchange rate system, an increase in current account deficit puts downward pressure on the currency of a country.
Pakistan, however, doesn’t exactly follow this model, and the State Bank of Pakistan, the country’s central bank, “occasionally intervenes in the foreign exchange market” to “quell excessive volatility and to ensure the smooth functioning of the foreign exchange market”.
During the period in question, Pakistan deliberately kept its currency overvalued.
In 2016, according to the IMF, Pakistan’s currency was overvalued by as much as 20 per cent. To achieve this, Pakistan kept pumping foreign currency into the market, even at the cost of a significant depletion of its foreign exchange reserves.
According to a report in Dawn this March, “When Ishaq Dar was Pakistan’s finance minister between 2013 and 2017, he ensured that the dollar’s price stayed around 105 rupees.”
It quoted a State Bank of Pakistan official as saying that “…he [Ishaq Dar] was fixated on keeping the exchange rate at 105 rupees… Every time there was even a slight movement in the exchange rate, our team would fly to Islamabad — sometimes even on Sundays — to explain its reasons to the finance minister”.
And to finance the current account deficit, Pakistan tapped into foreign capital inflows like “bilateral loans from friendly countries, bond auctions in foreign markets and the privatisation of state-owned enterprises”, the report added.
In November 2017, Dar resigned, and his resignation was followed by a series of devaluations.
By this time, the costs of debt servicing, which represent capital outflows, had increased.
According to a July 2018 report in Scroll, foreign exchange reserves came under added pressure“as a result of problems on both current and financial accounts”, and “declined from $16.14 billion on 30 June 2017 to $10.26 billion on 14 June 2018”.
In this context, devaluation became important. A devaluation can help in partly offsetting current account deficits by improving exports by making them cheaper, and reducing imports, which then become costlier. However, neither of the two things seem to have happened for Pakistan.
Further fall in rupee?
The weakening foreign exchange position sent a negative signal to the market, leading to an increased demand for the dollar and depreciation of PKR.
Similar sentiment was again seen in May this year when Pakistan accepted the IMF bailout and PKR breached the 150-per-dollar mark on the expectation that Islamabad would move towards a market-determined exchange rate, as demanded by the IMF.
Economist Kaiser Bengali, who has worked with various Pakistani governments, noted in a Bloomberg report this May that “this knee-jerk reaction of the market will continue…”.
“Given our large deficit and high debt ratio, the rupee will continue to decline. The rupee will be 200 a dollar by year-end,” he added.
However, another expert, Ahmed Ateeq, head of treasury at Karachi-based Pak Brunei Investment Co, offered a different view, saying, “The rupee will hover around 150 for now but we may see a 5%-6% drop by year-end that is normal for a nation like Pakistan”.
