The rupee-dollar interbank parity is close to the historical high of 168.8 (15 August 2020) this week past with a high of 168. Should this be a source of concern or can it be dismissed as the August/September blues?
Interbank rate on 31 May 2018, the PML-N tenure ended that day, was 115.61 rupees. This is on the back of foreign exchange reserves of 9.65 billion dollars and a current account deficit of 17.9 billion dollars as on 30 June 2018. In other words, the pressure of low reserves and a high current account deficit necessitated rupee depreciation.
The then Governor State Bank of Pakistan (SBP), Tariq Bajwa, an Ishaq Dar appointee, correctly noted that the current account deficit had soared to an unsustainable level as a result of rising aggregate demand in the economy which prompted him to allow the rupee to fall by 22 percent - from 105 rupees on 1 December 2017 to 128 rupees by July 2018 as well as raise the discount rate by 175 basis points to 7.5 percent.
Bajwa reportedly stated at the time "the real effective exchange rate (rupee dollar parity) and monetary policy (benchmark interest rate) are two effective tools available with the central bank to deal with the situation...we are using them both."
REER defined as a country's competitiveness fell from a high of 127.4 in April 2017, due to Dar's flawed policy of artificially keeping the rupee over valued with the International Monetary Fund (IMF) maintaining that the rupee was overvalued from between 5 to 20 percent in its quarterly review report, to 108.3 by the middle of 2018.
On 29 November 2018, the Fiscal and Monetary Policies Coordination Board (FMPCB) met under the chairmanship of Asad Umar, the then Finance Minister; the other important member of the Board notably Governor State Bank of Pakistan (SBP) Bajwa was also in attendance. The Board as per its usual agenda discussed monetary and fiscal policy challenges as well as the nature and extent of the pressure on the rupee.
The following day, Friday 30 November 2018, SBP depreciated the rupee by 3.8 percent or by 5.06 rupees to the dollar thereby reaching a historical low of 139.05 rupees to the greenback in the inter-bank market. In the open market the rate dropped to 144 rupees to the dollar. The reasons for the rupee erosion were obvious: a current account deficit of 20 billion dollars, a historic high, and REER of 107.
Prime Minister Imran Khan, the following Monday, 3 December 2018, while interacting with the media stated: "when the price of the dollar touched a record high against the rupee I [and Asad Umar] were not informed beforehand. The central bank devalued the currency and it's the institution that overlooks these matters," and added that he had instructed SBP not to take any decision on exchange rate without first informing him.
The Prime Minister's disavowal of prior knowledge of the depreciation was perhaps considered politic given his statement during a press conference on 23 March 2018, the tail end of the PML-N tenure, that the second big depreciation in a few months will increase the cost of living for the common man.
On 4 December 2018, it was revealed that Asad Umar was informed if not consulted by the SBP about the impending depreciation during the FMPCB meeting and he reportedly passed on the information to the Prime Minister. It is very possible that the information passed onto the Prime Minister did not register as at the time he was grappling with multifarious issues so the key question is whether he is aware that the interbank rupee dollar parity peaked in 2020 and, at present, is edging towards that peak.
On 26 August 2021 a meeting of the FMPCB was held in Islamabad presided over by Shaukat Tarin and attended by Governor SBP Dr Reza Baqir who while sharing the SBP analysis on policy rate, credit availability, exchange rate movement and inflationary situation, claimed that the policy mix was supporting the growth momentum which was Tarin repeatedly stated was now the administration's overarching objective; Baqir reportedly also "highlighted the increase in commodities prices in the global market which have implications for higher import bill and inflation."
Some home truths are as follows: till the departure of Dar the rupee was overvalued but almost as soon as he left the country the rupee was allowed to depreciate in accordance with the prevailing economic conditions. Till the appointment of Dr Reza Baqir as Governor SBP on 6 May 2019, the REER was at around 98 and discount rate at 10.75 percent - tools that were appropriately used by the FMPCB.
By July 2019, the REER plummeted to 89.7 and 91.7 in August 2020 but by October 2020 it rose to 97 and thenceforth has remained on average at around 100. The revised REER data for June 2021 is 99.8 while the provisional data for July 2021 is 99.42.
The question is was the decline in the rupee value from May 2021 to today - from 153 rupees to 168 rupees - indicative of a planned non-intervention by the SBP in the market due perhaps to the forthcoming sixth review talks with the IMF scheduled for this month? Or was it reflecting the REER reaching some sort of equilibrium? Those who support the former rationale argue that as the discount rate cannot be used as a tool due to political considerations the rupee is being allowed to depreciate to appease IMF's concerns with respect to managing excess demand (subsequent to the easing of restrictions) to fuel growth.
Those who conform to the latter rationale acknowledge that Dr Baqir perhaps took decisions contrary to SBP's past practice from 6 May 2019 till the pandemic March 2020 - notably linking the discount rate to CPI which included items that were not susceptible to the discount rate instead of core inflation (non-food and non-energy items) and allowing the rupee to be undervalued. However, today the data uploaded by the SBP indicates a reversion to previous practice: (i) a 7 percent discount rate with core inflation at 6.3 percent in August 2021; and (ii) a July 2021 REER of 99.4.
What is baffling is that the rupee erosion continues in spite of foreign exchange reserves of 20 billion dollars, a historic high even though more than 50 percent are debt based, a July-June 2020-21 current account deficit of only 1.8 billion dollars and a July 2021 current account deficit of 773 million dollars - neither a source of concern even though imports are rising at a much faster pace than exports.
Could it be because the 5 to 7 million dollar daily inflows from Afghanistan to Pakistan ceased subsequent to the 15 August 2021 Taliban takeover of Kabul? The parity on the day Kabul fell was 163.17 so perhaps the resulting erosion maybe attributed to that event, however, this does not explain the erosion from May 2021 onwards till today.
There are three possible conclusions.
First that the FMPCB members including Tarin as Chair and Dr Reza Baqir, decided to let the rupee value be set by market forces (the practice with respect to strong currencies like the dollar, euro, pound as opposed to a market based exchange rate agreed with the IMF which allows the rupee to operate within a range) and to stave off domestic criticism has manipulated REER and core inflation data. In this context it is relevant to note that concerns about the REER and rate of inflation have been raised by independent analysts.
Second, in deference to the Prime Minister's directive to keep him informed of a depreciating rupee the FMPCB has informed him of this strategy which is why he is silent on the rupee erosion perhaps by pointing out that an eroding rupee, laying it all on the Afghan factor, is preferable to a discount rate rise which may compromise the government's bottom-up approach as well as its top-down approach that is supportive of the large scale manufacturing sector?
And finally, the Board members have informed him of the feel good indicators rather than dwelling on the feel bad ones and the rupee erosion is certainly in the latter category. However, the feel good factors when seen in the context of a disenchanted citizenry paying the price of these policies not only through persistently high inflation but also through a massive escalation in the price of budgeted debt repayments (each rupee loss in terms of the dollar generates 100 billion rupee rise in debt repayments) the amount since June 2021 could well be in the range of 1.5 trillion rupees.
Copyright Business Recorder, 2021