Finance Minister Shaukat Tarin in his wind-up speech in parliament this Friday lamented the rupee-dollar parity which rose to 168 to 169 rupees to the dollar due to what he maintained was International Monetary Fund (IMF) condition thereby tacitly and unfairly absolving the implementers of this policy, who represented the people of this country, from blame.
The rupee value eroded to 158.239 to the dollar on 23 June 2021 against the low of 151.17 on 9 May 2021 (Sunday) with last Monday's rate at 152.23 rupees to the dollar. By Friday last the rate had come down to 157.55 to the dollar interbank and 157.80 open market.
On 28 May 2021, the rupee was trading at 154.6 to the dollar - the date is significant as the Monetary Policy Committee (MPC) meeting was held the same day and the subsequent statement issued (MPS) noted that positive developments (broad based economic rebound due to proactive and well calibrated accommodative fiscal and monetary policies achieved without compromising external stability - self-praise that has become the norm usually challenged by the team leader's successor) ensured that the rupee remains broadly stable at around its pre-Covid level since the last MPC meeting two months ago.
So what pre-Covid rate was the MPS referring to? On 17 March 2020 with just a few confirmed Covid-19 cases in the country Prime Minister Imran Khan in a televised address warned the public that the virus will spread but not to panic. The same day the rupee value declined to 159 to the dollar and by 7 April 2020 it was trading at 167 rupees to the dollar.
Be that as it may, the rupee value was relatively stable from 6 December 2019 to 8 March 2020 within the narrow range of 154 to 155 to the dollar - a period when the discount rate was 13.25 percent prompting an inflow of "fickle" portfolio investment of around 3 billion dollars - which has since left the country. However, the rupee was trading at 141.5 to the dollar on 8 May 2019. In other words, rupee declined more than 11 percent in 2019.
The exchange rate is a function of several macroeconomic indicators however government data reveals that most performed much better in 2020-21 than expected, as well as relative to previous years, due to considerable easing of the monetary and fiscal policies in the aftermath of the pandemic. This accounted for a Gross Domestic Product (GDP) growth of 3.94 percent, foreign exchange reserves with the State Bank of Pakistan (SBP) rose to 16.1 million dollars as of 24 June 2021 (though nearly half are from swap arrangements and borrowings) and remittances registered a 29.4 percent raise - from 20.1 billion dollars (July-May 2019) to 20.6 billion dollars in the comparable period 2020 to 26.7 billion dollars in the current year.
Trade balance, however, was negative 21.3 billion dollars by April 2021, negative 17.5 billion dollars April 2020, and negative 23.3 billion dollars in April 2019 leading to the conclusion that in spite of easing of monetary and fiscal policies post-pandemic the trade balance, notwithstanding claims of a rise in exports, is widening and is projected to widen further though reversal of the "accommodative" policies would contain the trade deficit but then contain the growth rate as well.
On the back of higher remittance inflows current account remains in surplus. The reason behind this rise is claimed by Khan loyalists' as indicative of the love of overseas Pakistanis for the Prime Minister though time will tell why it took overseas Pakistan three years to express their love and whether once the pandemic is dealt with globally remittance inflows through hundi/hawala would not be restored to pre-Covid19 levels.
Thus the obvious implication of a rupee decline from 156.7 rupees to the dollar on 11 June 2021 (the day the budget was announced though the rate used to calculate debt servicing is lower based on the applicable rate at the time the budget was prepared) to 158.2 on 23 June 2021 would be on the calculation of the budgeted debt repayment, which would rise, revenue generation from imports, thereby compelling the government to scale down allocation on PSDP to contain the deficit.
IMF released 1.6 billion dollars under the Rapid Financing Instrument in April 2020 to assist the government cope with Covid19 and noted three monetary policy decisions: (i) cutting the policy rate to 11 percent (too little as it turned out and it took the MPC another two months - 25 June 2020 - to bring the rate down to 7 percent where it stands today) and noted that SBP intervened in the market to prevent "disorderly market conditions by allowing the exchange rate to act as a shock absorber, accommodating an 8 percent depreciation (the rupee hovered from between 159 to 161 rupees to the dollar during this period prompting speculation of SBP intervention); (ii) expanded refinance schemes, new facilities in support of employment, manufacturing, hospitals, etc.; and (iii) reduced capital conservation buffer by 100 basis points, allowing banks to defer clients payment of principal and increased regulatory limit on extension of credit to SMEs.
The IMF warned the government in April 2020: "that intervention in the foreign exchange market should remain limited to prevent disorderly market conditions...regulatory measures and expanded refinancing schemes must be targeted and temporary, and their design should not create moral hazard nor foster poor credit risk management practices."
By April 2021, the IMF in its second to fifth review document again warned that "the market determined exchange rate has supported external adjustment and reserve accumulation" though without doubt remittances played a much more critical role; and argued "that once the crisis starts to abate the authorities should phase out the temporary Covid-19 response measures. The 28 May 2021 MPC noted that the time for phasing out response measures has not arrived adding that it is important "for monetary policy to remain supportive."
Today, the Covid-19 third wave has receded as per the government data and one may assume that the pressure is on by the Fund to begin withdrawal of these accommodative policies - a pressure that, amongst other factors including presenting alternative policies to those agreed by Dr Hafeez Sheikh in February this year with respect to the power and revenue sectors, may have contributed to the inconclusive sixth review.
Economic theory dictates that if inflation is high relative to trading partners then the currency would lose value in which case the usual approach is to raise discount rates. Pakistan's inflation has been estimated at over 11 percent with food inflation in excess of 15 percent. In contrast Indian inflation was estimated at 6.3 percent with food inflation around 5 percent, China's inflation rate of 1.3 percent with food inflation less than 0.78 percent, Bangladesh inflation is under 6 percent, Nepal's 3.65 percent and our major trading partner the European Union registered 2 percent in May 2021 while the UK registered 2.1 percent. It is baffling why the SBP and the finance ministry led by Dr Hafeez Sheikh remained oblivious to their own policies contribution to the exchange rate and focused on mafias (read collusion) and supply side issues as the major reasons behind inflation - including higher reliance on domestic and foreign debt (irrespective of the high cost of borrowing which is likely to rise further as Financial Action Task Force has decided to keep Pakistan on the grey list perhaps prompting Morgan Stanley Capital International to reclassify Pakistan in frontier markets rather than emerging markets), worsening terms of trade with major import items (including food and fuel imports) becoming more expensive relative to our exports.
And finally, the SBP website notes that the real effective exchange rate in April 2021 (provisional) was 103.298 while in March 2021 it was 100.8. The SBP claims that an index of 100 should not be misinterpreted as denoting the equilibrium value of the currency (100 represents the value in 2010) - a view not shared by previous SBP governors. Be that as it may, it may be recalled that, amongst others, Ishaq Dar's major blunder with respect to his handling of the economy was in overvaluing the rupee just so he could understate his borrowing spree and the REER in June 2017 was 121.
To conclude, critics of SBP policies argue that since May 2019 the REER has been consistently under 100 - a situation that was reversed in March 2021 when Dr Hafeez Sheikh was fired fuelling speculation that there may have been considerable pressure on the SBP to support pro-people policies. Supporters cite "disorderly market conditions" as the reason behind the recent REER data. But whichever side one may support the fact remains that the Fund is likely to remain vigilant to ensure that it is market based.
Copyright Business Recorder, 2021
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