What PKR Depreciation means and what Pakistan should do

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PKR is vacillating around RS 153 per US$ and is speculated to go above Rs 160 and even some says above Rs 200 in the coming months. In Sept 2018 it was at Rs 121/- .

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. Rumors are also in the market and government is going to dismantle Money Changers business. Some so called economists are clapping on this but they don’t know the actual depth of the matter. 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. Basically one must understand that with other factors like current, fiscal deficit, inflation plays main role in its appreciation or depreciation. From this angle decision of SBP in its monetary policy decision announced on 20th May 2019 regarding increase of discount rate by 150 bp looks right. But people must also understand also that currently Pakistan is also suffering from stagflation that is with increase on inflation productivity is not on increase and unemployment is not going down. So at this moment it was better to hold discount rate till budget announcement.

Important Data
  Exchange rate US$/PKR Nominal increase Increase in % *NEER Base 2010=100 **REER Base 2010=100
2003 (Musharaff) 57.7 164 94
2008 (PPP) after 5 years 80.4 22.7 40 120 96
2013 (PML N) after 5 years 106.1 25.7 31.96 86 104
2018 (June) PTI start of the government 121.6 15.5 14.60 80 111
May 2019 PTI after 9 months 153 31.40 25.82 70.20 103.31
  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 with External Debt $ in billions
2003 (Musharaff) 16.407 7 -31.271 for whole FY 18. -19,896 (9 months) -19,896 for whole FY 18. -11,421 (9 months)  

 

2008 (PPP) after 5 years 11-23 7 -19,366 (9 Months -8.,844 (9 Months)
2013 (PML N) after 5 years 14-18 7.5 -1,015 -6
2018 (June) PTI start of the government 16 7.5 -20.196 -4.6 Rs 17 trillion  Extern Debt $76.30
May 2019 PTI after 9 months 16 12.25 -20.204 -12 Rs 19 trillion  Extern Debt $100 billion
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 nominal effective exchange rate (NEER) is an unadjusted weighted average rate at which one country’s currency exchanges for a basket of currencies.

 

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 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.

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.

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 2019. 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. Secondly SBP should improve its monitoring system strictly and any money changer found holding above to allowed money (they have to surrender excess money on each day to the banks) who so ever may be punished immediately.

Apart from this IMF may be approached 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 18 and 19 we see decrease in NFA by Rs 555 billion in FY 2018 and Rs 739 billion in FY 2019. Contrarily NDA increased by Rs 1002 billion in FY 2018 and Rs 1442 in FY 2019. 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 32.0 trillion. Secondly it would also bring constraint on State Bank to push its discount rate upward which they have done in May 2019. This would slow down the pace of growth further i.e. already below 3 % as per multilateral reports. So they should avoid such action for the time being.

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 coming budget to calm down market for a bit.

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