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The rupee has taken a real beating last week, falling by 8 percent with respect to the dollar. There are both structural and short-term reasons for this precipitate fall.

The latter are due to the political uncertainty created by the somewhat unexpected outcome of the Punjab by-elections and by the downgrading of Pakistan’s credit rating by Fitch and earlier by Moody’s.

The underlying structural reason is, of course, of the very large current account (C/A) deficit in the balance of payments in 2021-22. It exceeded $15 billion in the first eleven months and has probably approached $16.5 billion by the end of the year, equivalent to over 5 percent of the GDP. It is the second largest deficit ever after the $19 billion deficit in 2017-18.

There is a fundamental difference between the causes of the large deficits in 2017-18 and in 2021-22. During the former year, with a relatively buoyant economy, there was an upsurge in imports, especially in the presence of a substantially overvalued rupee.

The big deficit last year is largely attributable to higher commodity prices following the global recovery from Covid-19 and more recently due to supply shortages created by the Russia-Ukraine War.

Almost three-fourths of the rise in the value of imports in 2021-22 is due to higher prices. Exports have also performed well but have been unable to make a dent on the trade deficit as they are only 40 percent of imports, which have shown an even higher rate of growth.

The fundamental pre-requisites to prevent uncontrolled hemorrhaging of the rupee in coming weeks and months is, first, the restoration of the IMF programme and, second, prevention of a further build-up of a large current account deficit in 2022-23. This is essential to ensure that the external financing requirements are kept within the limits of availability of external inflows.

The finance minister has developed an appropriate basis for determining the extent of reduction required in the current account deficit. He has indicated that from the viewpoint of sustainability, the target in 2022-23 should be that the level of imports of goods should not exceed the combined sum of exports of goods and worker’s remittances.

This gap is likely to be of $8.5 billion in 2021-22. Achievement of this target will ensure that the current account deficit remains confined to the trade deficit in services plus the net outflow of primary income minus other current transfers. This magnitude is likely to be close to $8 billion in 2021-22.

The objective of this article is to determine the intensity of use of the available monetary and fiscal instruments to achieve the equality between imports of goods and the sum of the export of goods and workers’ remittances in 2022-23.

The extent of curtailment in imports will hinge on the likely performance of exports and remittances in 2022-23. Also, the trends in commodity prices will indicate the extent of pressure on the level of imports.

The latest report of April 2022 on the World Economic Outlook by the IMF contains projections of the likely average level of commodity prices in 2022 and in 2023, respectively. Suitable averaging has enabled the conversion of the price estimates to the estimated level in 2021-22 and the projected level in 2022-23.

The derived estimates of the likely growth rates in import prices of different commodities diverge widely, as follows:

  • Double-digit increases are likely in the prices of crude oil, petroleum products, natural gas, and coal in 2022-23 of between 13 percent to 27 percent. Therefore, although there is likely to be a fall in these prices in coming months from the peak level in the second quarter of 2022, the average for 2022-23 will still be higher than the average for 2021-22, because these prices were low in the first two quarters of 2021-22.

  • Single digit increases in prices of imports by Pakistan of food and agricultural and industrial inputs, ranging from zero to 5 percent.

  • Close to the same average international price in 2022-23 as prevailed in 2021-22 for the bulk of other traded commodities.

A forecast of the increase in the average dollar price of imports, based on shares in the import bill in 2021-22, is of 8 percent in 2022-23. As such, there will continue to be some pressure on the level of imports of Pakistan in 2022-23. It is perhaps too optimistic an assumption that the on-going global recession will bring down the overall level of commodity prices in 2022-23 in relation to the average level in 2021-22.

Exports are unlikely to sustain the high growth rate achieved in 2021-22 because of the on-going global recession and due to loss of some competitiveness resulting from the increase in domestic energy and transport administered prices. As such. The projected growth rate of exports is from 8 to 12 percent.

Remittances have exhibited a moderate growth rate of 6 percent in 2021-22.

The recession and higher rate of inflation in developed countries is likely to reduce the outflow of remittances from these countries. The growth rate of remittances to Pakistan is likely to be low at 2 to 4 percent. The growth rate of the GDP in 2022-23 is projected to range from 3 to 3.5 percent.

The BNU Macro-econometric Model has been used to estimate the impact of different variables on the volume of imports as follows:

===========================================================================
                                                     % Change in volume of 
                                                                    imports
===========================================================================
1%-point higher GDP growth rate                                        0.94
1%-point higher real interest rate                                    -1.58
1%-point increase in the unit value of imports (in Rs)                -0.31
===========================================================================

Applications of these elasticities will enable determination of the extent of the required depreciation in the value of the rupee and the increase in the SBP policy rate to ensure that imports and restricted to the targeted level in the three scenarios. It is assumed that ¼th of the contraction is achieved by enhancing interest rates and ¾th by depreciation of the rupee.

The revealed magnitude of change in the monetary variables is as follows:

==================================================================
Change in % points in policy rate          3.00       2.50    1.75
level from present level o
Extent of Depreciation of the             37.25      33.25   26.75
rupee (end-periods* of years)
==================================================================
*Rounded off to the nearest 0.25% point
==================================================================

Therefore, there will be need for big policy moves, especially in the realm of monetary policy, if the current account is to be restricted to below $8.5 billion in 2022-23, by ensuring that the level of imports of goods does not exceed the sum of exports of goods and workers’ remittances in 2022-23.

These big moves have become necessary if Pakistan is to continue making its import and external debt repayment obligations in 2022-23. Other countries in similar situation like Turkey, Sri Lanka and Argentina have seen the number of their national currency units to buy a US dollar rise by 107, 85 and 35 percent respectively in 2021-22. Some of this has been due to the appreciation in the value of the dollar which has had a global impact on currencies.

The GDP growth rate is projected at 3 to 3.5 percent in 2022-23 and the rate of inflation from 22 to 24 percent.

Copyright Business Recorder, 2022

Dr Hafiz A Pasha

The writer is Professor Emeritus at BNU and former Federal Minister

Comments

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Rebirth Jul 28, 2022 12:58am
Reduce the interest rate to single digits and increase tarifs by double digits on inelastic imports. It’s quite simple. More credit availability means more economic activity and if the imports stay stable, that’ll bring in more tax revenue to compensate for making more credit available.
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