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The currency is under pressure. After crossing 164, the PKR/USD closed at 163.89 yesterday. This is the lowest level since Oct 20, and in the recent spurt PKR has depreciated by 7 percent from its peak. The question is when will this depreciation stop, what is the ideal level of currency, how much should SBP intervene to counter rising imports due to growing demand and rising commodity prices, and what are the other policy responses by SBP and MoF to lower the pressure on currency depreciation.

Pakistan is experiencing somewhat flexible exchange rate regime for the first time in history. Ever since this phenomenon, it is the second time the currency is depreciating and sending jitters. In the first case, it was primarily due to COVID related outflows in March20. It was primarily due to hot money outflows. Today, there is no hot money; but every commodity is piping hot. That is driving the import bill and letting the currency depreciate.

It is hard to point exact level of currency when it is market driven and sentiments do play a role in either way movement. There are clear indications that SBP is intervening. This is evident from the fact that for the week ending 23rd July, SBP reserves fell by $220 million and there was no debt repayment. This means that reserves fell as SBP provided dollars in the market. SBP stated policy is to intervene in the market to curb volatility (to abate disorderly market conditions). However, the institution is not altering the direction of the currency which is downwards.

If someone thinks that the market can operate without SBP intervention, they live in a fool’s paradise. There is no way to finance current account deficit apart from capital and financial flows (foreign investment and debt) or by burning reserves. The market doesn’t have ammunition. One must choose on how much to intervene as without it, this could be a free fall. Not desirable at all.

The other point to contemplate whether flexible exchange rate is the right policy in case of rising commodity prices. Well, the currency depreciation is a double whammy, as the pressure on domestic prices would come from both dollar and rupee increase in prices. That is too much to handle and must be delt with a combination of factors.

One is to let the currency to adjust a bit to curb demand. The other is to raise interest rates a bit to curb demand. Third is to do away with expansionary fiscal (or political) stance. For example, petrol sales are all time high – some of this is to higher tourism and general demand and the other factor is due to not passing on the impact of higher prices to consumers. Government must increase prices as currency depreciation has larger inflationary consequences.

Then there are other factors. Government has reduced duties on imported cars (electric) and on CKD kits for domestically produced cars. Consumers are booking cars like anything. The higher number in July is based on previous months demand as supply was low in June as people were expecting prices to fall in July. But the impact of low duties will become visible in months to come. And with currency depreciation, some car makers may increase prices again. The consumer benefits may fully or partially offset while the currency depreciation will impact economy at large.

The SBP should manage the float by anchoring it to certain fundamental factors such as REER, current account deficit and overall demand and supply of dollar. After reaching that level, it should intervene to manage market expectations and to avert dollarization in the economy as average Joe is thinking again to move from PKR to USD. Not healthy.

The fiscal management needs to be prudent. The foremost need is to not fiddle with international oil prices and pass on the commodity prices impact to consumer. Otherwise, the consumer would pay it anyways in the form of PKR depreciation. Then the government should focus on generating higher debt-based flows (as liquidity is better international market) and wait for the investment flows to come in or commodity prices cycle to reverse.

The demand supply situation is fluid. Remittances’ flow is slower after Eid and slight opening of travel – especially in the US – where the remittances growth was the highest. Exporters are waiting to bring dollar in anticipation of further depreciation to extract maximum juice. The SBP should give a signal end the greed of exporters. This export biased policy needs to be revisited. The capital flows are not completely open. Import substituting companies are at a loss. Corporate having foreign partners could not time the market as outflows has ques while inflows (exporters) are timed to their interest. SBP should look at balancing the act. And both MoF and SBP should have a coordinated policy which is best for all under the pressing circumstances.

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