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The blame game as to which factor is more predominant in the erosion of the rupee is continuing. The Pakistan Tehreek-e-Insaf (PTI) leadership blames it on the flawed economic policy decisions of the coalition government and inability to take corrective measures laid at the doorstep of incompetence and corruption.

The Shehbaz Sharif-led government maintains that it can be traced back to the politically motivated relief package announced by Imran Khan on 28 February 2022 as well as the anti-growth and anti-poor policies negotiated with the International Monetary Fund (IMF) in 2019.

The rupee on 10 April when the vote of no-confidence against Imran Khan was passed was 186.28 against the dollar (interbank) while on Thursday it plummeted to 240 – a decline of more than 64 rupees that has no doubt: (i) massively raised the debt servicing component of the budget which previous research indicates will cost the treasury an additional 100,000 rupees for each rupee loss of value to the dollar.

Given that the budget for the current year took the parity at 183 rupees to the dollar, the revenue required to bridge this growing gap should ideally have been dealt with through a massive cut in current expenditure; however given Finance Minister Miftah Ismail’s recent statements reliance would be on incurring external loans of a little more than 40-billion dollars – a target that compares unfavourably with the 45 billion dollars Imran Khan administration borrowed from abroad in three years and eight months; (ii) raised the cost of imports particularly fuel and cooking oil which is highly inflationary reflected in the consumer price index of more than 20 percent in June and over 30 percent in last week’s calculation of sensitive price index that measures price fluctuations in 51 items of general use; and (iii) the downgrade in Pakistan’s outlook by all major international rating agencies that raises questions about the country’s ability to pay back past loans as well as our ability to borrow on concessional terms.

One obvious question is why isn’t the State Bank of Pakistan (SBP) taking appropriate measures to stem the rupee erosion? Reserves have declined to 8.5 billion dollars, less than a month and a half of imports at today’s commodity prices, which implies that market intervention is simply not possible. Miftah Ismail recently stated that the government is not allowed to intervene in the currency market as per IMF conditions which, true to form, he blames entirely on the Khan administration.

But as always he fails to address criticism that he could have created some leverage in negotiations with the Fund by slashing expenditure instead of upping it by one trillion rupees in the current year that, in turn, accounts for the Fund insisting on limiting subsidies and raising taxes on the middle income earners — those earning from 50,000 to two lakh rupees per month. Ismail further added that the acceptance of a market based exchange rate in the ongoing programme has disabled the SBP from intervening in the market unless disorderly market conditions prevail. The question is: do such conditions prevail?

The two former employees of the Fund notably, Finance Minister and the Acting Governor of the SBP need to brush up on the definition of disorderly market conditions as highlighted by the Fund in an article titled Monetary and Capital Markets Special Series dated 18 February 2021: exchange rate volatility (intra-day or day-to-day) is the most commonly used indicator of market impairment. Exceptional volatility often reflects low liquidity, uncertainty regarding the equilibrium price, and impaired price discovery.

In addition, exchange rate fluctuations beyond a certain level could result in sudden shifts in expectations, closing of large positions, and herding behavior among market participants, leading to persistent volatility and a double exchange rate overshoot. Among other indicators, high volatility is considered as reflecting disorderly market conditions.” Indeed, losing around 2 to 3 rupees per dollar every day can be categorized as exceptional volatility.

The above cited article also argues that: “Exchange rate volatility due to market impairment can threaten financial stability via the large valuation swing it could generate on unhedged FX exposures. FX interventions could, therefore, contribute to the central bank’s typical mandates of price and financial stability by mitigating excessive volatility while still allowing the exchange rate to adjust to new equilibrium. Consistent with IMF policy, rationales should not include sustaining misaligned exchange rates or substituting for warranted macroeconomic adjustment.

Support to FX markets, in this context, complements monetary policy but does not directly aim at implementing a monetary policy stance.” This rationale indicates that perhaps the pressure on the rupee may be supported by the Fund as the 15 percent discount rate is not in the Fund’s view reflective of a positive rate of return and hence either the SBP would have to raise the rate further, which would further constrain output by the large manufacturing sector, or allow the rupee dollar parity to worsen which is already fueling inflation.

And finally, the article cites three foreign exchange markets notably: (i) spot market which is being led by the open market that appears to be closely following the interbank rate plus minus a rupee or two; (ii) derivatives FX market which is suffering a severe dollar shortage disabling many an importer from getting his stocks released from warehouses and many an exporter from importing raw materials/semi-finished products; the Fund advises that managing the demand for hedges would have positive spillovers in the spot market due to the interconnections between these markets; there appears to have been no attempt by the SBP to manage this market in recent weeks; and (iii) funding markets (borrowing and lending) and since Pakistan’s reserve position is extremely weak and Ismail has already boasted of heavier than ever reliance on inflows from multilaterals that would reportedly uncork pledged assistance from friendly countries Pakistan’s indebtedness would rise irrespective of the fact that loans may be at concessional terms payable in the long term.

To conclude, the rupee is in the throes of an exceptional volatility which reflects disorderly market conditions and therefore there is an urgent need for some major revisions in policy instead of passively waiting for external borrowing to begin to be disbursed.

Copyright Business Recorder, 2022


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