Impact of PKR Depreciation on economy

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Muhammad Arif
Mumammad Arif : Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

PKR is vacillating around RS 134-135/- per US for some time. In Sept 2018 it was Rs 121/- . Hence within a month it has depreciated by 14%.

This has started a discussion in the media and notable circles that what are the actual reasons of this depreciation. Some circles are blaming IMF for the actual cause and some are putting its responsibility on mismanagement of the government and SBP. So everybody is trying to save its skin and blaming others for such drastic depreciation.

Exchange rate policy by definition and practically is part of monetary policy. It underwent several changes since 1949 in Pakistan in different tenures.

Data on change of governments
Exchange rate US$/PKR Nominal increase Increase in % *NEER Base 2010=100 **REER Base 2010=100 FX Reserves $ in billion Prime rate of SBP in % Trade Balance-$ in billions Current A/C Balance-$ in billions Govt Total Debt Rs in trillions External Debt $ in billions
2003 (Musharaff) 57.7 164 94 7.5 -1,015
2008 (PPP) after 5 years 80.4 22.7 40 120 96 15 -20.196
2013 (PML N) after 5 years 106.1 25.7 32.5 86 104 11.019 9 -20.204 -12 25.1 66.1
2018 (June) PTI after 5 years 121.6 15.5 14 80 111 16.407 7 -31.1 -18 29.8 75.3
Nov 2018 PTI after 4 months 135 14 12 79 111 16.685 8.5
*The nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of multiple foreign currencies. In economics, the NEER is an indicator of a country’s international competitiveness in terms of the foreign exchange (forex) market.

**The real effective exchange rate (REER) is the weighted average of a country’s currency in relation to an index or basket of other major currencies, adjusted for the effects of inflation. The weights are determined by comparing the relative trade balance of a country’s currency against each country within the index. An increase in REER implies that exports become more expensive and imports become cheaper; therefore, an increase indicates a loss in trade competitiveness.

The foreign exchange market in Pakistan gets its inflows through export proceeds, remittances and FDI. The amount received from IMF is for meeting current account deficit and does not add up in to FX market activities. Further SBP intervenes some time to smooth out the market that can come under pressure on account of lumpy payments or can come out of pressure on receipt of some major amount. Under financial sector reforms started in 1991, current account has been made totally convertible in 1993, meaning that any foreign account holder (FE-25) can send its money outward without any restriction. Likewise this account can receive amount in cash or from outside without any restriction. In capital market investments, the amount can be sent in or send out through SCRA, an account maintained with the banks on behalf of investors. Capital account convertibility is not yet allowed in Pakistan.

At the end of Musharraf era, the year FY08 remained volatile for the FX market, witnessing huge contraction in the NFA i.e. around Rs 375 billion. This figure coincided with depletion in the bank deposits remaining to the same quantum. The outflow mainly went to the Gulf States for better investment opportunities. At that time the PKR depreciated by more than 18%. However on access of IMF aid, the things started moving towards some improvements, but these were short term arrangements. Opportunities existed to encash them on the back of declining inflation and world coming out of recession. Forward points, an indicator of future trend of FX market went as high as Rs 3.72 per US $ in June 08 started softening thereafter. FX reserves also improved which are required mainly to support import obligations and to support FX market in case of its dire need to avoid undue fluctuations in nominal exchange rate. However the reserves fell to the ground in FY 2013-14 at $ 11.0 billion. The reserves in FY 2016 went up to $23 billion, in FY 2017 $ 21.4 billion, in May 2018 it again fell down to $ 15.9 billion however in August 2018 they are around $ 17 billion.

Another disciplinary arrangement for FX market i.e. Foreign Exchange exposure limit (FEEL) implemented by the SBP after replacing NOSTRO limits had made the market flexible and disciplined to move within some range of banks paid up capital. Previously they were 10% of paid up capital and now at 20%.

The market players in this regard have always remained Government, SBP, Interbank market, Parallel market i.e. KERB through money changers, FX dealers of the banks and corporate sector.

FX market in the world with 40% transactions centered in London carry $5.3 trillion per day in trading volume, thus making the size of equities and futures markets very small. In fact, it would take thirty days of trading on the New York stock exchange to equal one day of Forex trading transactions. After scrap of fixed rate in 1970 period the dollar has emerged as main reserve currency of the world that also moved up and down with Fed interventions and on world economic outlook. This is how the FX market structure is. As stated its parity between two currencies depends on inflation or interest rate parity basically meaning purchasing power parity. So  if we consider Rs 135.0 as parity rate on Nov 2018, than considering USA inflation rate as 2.5 % and Pakistan coming inflation rate as 6%, the parity comes out as 135.0*1.06/1.025 = Rs 139.60. In case the inflation of Pakistan inches up than the PKR can depreciate further.

Now this is the simple mathematics but actual market moves on other factors as well, like on speculation or SBP actions in the market. These two factors have actually worsens the situation.

In fact behind this stand IMF agreement as its one clause can always demand to Increase central bank reserves to over 3 ½ months of imports.  As part of the agreement it means to raise FX reserves to $ 20 billion in 2018/19. In this regard the touchable areas are to increase FDI, Portfolio investments and to reduce import/export gap and to enhance donor aid on better terms. Since for these areas law and order situation is not conducive nor energy crisis is going to tapper down so it looks that this target cannot be achieved.

Now to improve reserves what could have been the better strategy? It is very simple. Like 1990-2000 era each bank in the interbank market should hold dollars up to some level like Money changers do by surrendering excess dollars to the interbank market. Against surrendered amount to the SBP banks should pay some premium to SBP making them eligible to procure dollars up to their needs as and when required.

Apart from this IMF may be approached (discussions are already going on) whether you like it or not to get more dollars above $ 6.8 billion (hardly sufficient to meet its repayments to IMF) to set some benchmark for getting loans from other multilaterals and through bilateral sources at better rates. Pakistan at the moment requires some relieving space to overcome its economic miseries. I.e. bringing growth and inflation at some positive levels i.e. Inflation below 8 % pa and growth above 5% pa. Meanwhile within a year or two, government may try to control law and order and energy issues to completely focus on its economic agenda.

Now another issue relevant to depreciation is the fiscal deficit but we all should understand that NFA and NDA makes reserve money i.e. money required by the market.  If we look in to FY 17 and 18 we see decrease in NFA by Rs 204 billion in FY 2017 and Rs 817 billion in FY 2018. Contrarily NDA increased by Rs 1098 billion in FY 2017 and Rs 1434 in FY 2018. The increase in NDA is somewhat on the higher side but if it would have not been increased than the market would have gone in to severe crunch. Hence if NFA position starts getting better than fiscal deficit would obviously come down.

In the coming future increase in parity rate would first of all increase public Debt to the tune of 29.8 trillion (Considering $ 75.3 as foreign debt as of June 2018). Secondly it would also bring constraint on State Bank to push its discount rate upward by 50-100 bp i.e. going to 9-10 % in Nov, 2018 MPS. This would slow down the pace of growth further i.e. already below 5 % as per multilateral reports.

So what should be the immediate steps to improve PKR status?

  1. No buying from the interbank market. Instead they should be asked to surrender dollars to SBP above some stipulated level. They should be asked to pay some premium to the SBP for getting right to procure dollars as and when required.
  2. Stringent inspection of interbank market and KERB, where no L.C is being honored in time and no export proceeds is coming in time. How one can say that SBP is doing its duties.
  3. Approach to IMF for getting excess dollars above amounts extended to meet repayment schedule. This would provide some relieving time for the SBP and government to straight out their matters.
  4. Getting funds from other multilateral agencies and on bilateral basis. These funds should be diverted towards poverty alleviation, Health and Education.
  5. Curtailing imports rather than on focusing on exports. Leaving aside oil and edible oil that are inflexible other imports should be minimized as possible as we can.
  6. Some restraints on increase of discount rate at least till next MPS to calm down market for a bit.

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