The Pakistani rupee has fallen sharply against the dollar in recent weeks, and most analysts and economists are of the view that the local currency’s slide will continue in 2018.
There are many factors which are responsible for the rupee’s weakness versus the greenback, including a widening current account deficit, as well as a deteriorating fiscal deficit.
Although, these factors have been there for a while, the rupee’s slide was prevented previously due to the stubbornness of Ishaq Dar, former finance minister. He was adamant at not letting the rupee behave according to market fundamentals and artificially protected its value, and once he left office, the rupee fell sharply.
In fact, it was the decision to allow the depreciation of rupee last year that cost Riaz Riazuddin, the then acting governor of the State Bank of Pakistan, his job. While, it came as a welcome surprise to the market as well as economists, it didn’t go well with Dar earlier. As a result, Riazuddin was not only removed from the job, but also faced an unnecessary inquiry.
There is a consensus among analysts that the rupee’s devaluation is needed, but it is also imperative to look for ways to control the fundamental problems of the economy.
There are fears that the government might be forced to go to the International Monetary Fund (IMF) again owing to its failure to control the widening current account deficit. There has been limited growth in exports, and most of the country’s industries have become uncompetitive globally due to rising costs. At the same time a greater dependency on imported items means a rising import bill, and thus a burgeoning trade gap.
Narratives spoke to Pakistan’s three leading economic analysts to see how they think the rupee will perform in 2018.
Depreciation Won’t Work
Dr. Ashfaque H. Khan, Principal and Dean of NUST School of Social Sciences and Humanities
I won’t forecast on what the rupee’s value would be but will say that it will continue to remain under pressure because of balance of payment issues.
But more importantly, we need to realise that relying solely on the exchange rate depreciation is not going to solve the country’s balance of payment problems. This is like relying exclusively on a monetary policy instrument to revive economic activity which will not work for a developing country.
Devaluation should be linked with other policy measures, for example, Pakistan needs to arrest the rising trade gap, as our imports are twice as high as our exports. We should first be focusing on why our exports are decelerating and why our imports are rising.
The reason our exports are on the decline is because of senseless taxation, which has added to the cost of production. Moreover, withholding refunds of exporters, has created liquidity problems for our export-oriented industries.
In mid-2014 and onwards when oil prices saw a sharp decline, many of Pakistan’s competitors passed on the bulk of benefits of low prices to their domestic consumers, including domestic producers. However, we did not do that completely and tried to get more through taxation and instead earned revenue through the global decline in oil prices. Since we depend heavily on imported furnace oil, its prices weren’t reduced as much as the international prices, therefore we were unable to make ourselves competitive.
The poor governance in the country made the circumstances worse. While we were facing these problems, neither the prime minister, nor the finance minister or the concerned minister of trade were looking to find solutions, which resulted in a communication gap between the exporters and the government.
Among all this, we maintained a fixed exchange rate regime. A combination of all these factors led to the erosion of our competitiveness in the international market.
In my view, the larger the content of imported inputs in our export-oriented industry is, the lesser would be the impact of devaluation. When we devalue our currency, the cost of imported inputs will go up and if it has a larger share, it will not benefit the exporter as their cost of production will further go up. Also, when a country like Pakistan exports to companies in the United States or in Europe, wherever our currency is devalued, our importers will simply ask the exporters to reduce their unit value.
In other words, the bulk of the benefits of devaluation will be passed on to the importers. So, empirical evidence suggests that devaluation alone has not worked and it will not work.
Twin Deficits Risk
Asif Qureshi, CEO, Optimus Capital Management
Pakistan is facing significant risks to its macroeconomic stability stemming from the widening twin deficits i.e., a snowballing current account deficit and a sharp deterioration in fiscal deficit. While the rupee has devalued by 5.5 percent since June 2017, it still faces strong headwinds and shall likely depreciate by another 5-10 percent in 2018.
The country’s current account deficit reached $12.4 billion (4.1 percent of GDP) in FY17 – the highest since the economic crisis of 2008, and indications are that it may cross $15 billion in FY18. While higher GDP growth and pickup in investment (including but not limited to CPEC projects) have contributed to higher imports, the rupee’s overvaluation and structural changes in the economy, with growth driven largely by non-export oriented sectors, have also fuelled imports. Pakistan’s goods imports, excluding petroleum, increased by $11 billion between FY14 and FY17 and less than 26 percent ($2.9 billion) of this increase was due to higher machinery imports. Sharp deterioration in fiscal deficit, which reached 5.8 percent in FY17 as provinces used past surpluses to ramp up spending, has also not only added to aggregate demand (further fuelling imports) but also exposed the structural flaws created by the combination of the 7th NFC and the 18th amendment in the administration of fiscal policy.
The composition of Pakistan’s GDP growth has changed in recent years with non-traditional sectors such as real estate and services driving growth while the performance of agriculture and export sectors has been generally weak. These structural changes have further shifted the balance of trade in favour of imports. Moreover, the pick-up in investment activity thus far is largely concentrated in the infrastructure sectors, which although necessary, shall not translate into significant near term gains in exports, while repatriating returns on foreign funded projects shall see higher forex outflows in the coming years.
Last but not the least, international oil prices have rebounded sharply after staying low for more than two years, which shall further add to the energy import bill in the second half of FY18.
The growing risks to macroeconomic stability require prompt and prudent policy actions. In the near term, there is little alternative to slowing down aggregate demand i.e., sacrificing GDP growth to restore macroeconomic stability. Meanwhile, structural reforms have to be undertaken to put the country on the path of sustainable and inclusive higher growth trajectory. Removing currency overvaluation, reducing fiscal deficit and tightening monetary policy, while politically undesirable are becoming inevitable and shall have to work in tandem to reduce growing pressures on the external account.
Slide to Continue
Mohammed Sohail, CEO, Topline Securities
After remaining stable for almost two-and-a-half years, the rupee depreciated by 5 percent against the dollar in the interbank market during December. This was largely due to change of command at the Finance Ministry and pressure from donors. But what is important is that this was likely the first phase of currency devaluation, and the second phase of a similar magnitude will follow during January –June 2018.
Further, given expectations of current account deficit of 4.0 percent-4.5 percent during the next few years, coupled with high gross external financing requirements, the rupee’s depreciation post fiscal year 2017/18 (July-June) is expected to be around 6 percent annually, as against earlier assumptions of 3-4 percent.
The State Bank of Pakistan (SBP) said on December 8 that high growth in imports (Jul-Nov 17 imports up 23 percent to $22 billion) led to widening of the current account deficit (Jul-Nov 17 current account deficit up 90 percent to $6.4 billion), and depletion in the country’s foreign exchange reserves (July 1 to date foreign exchange reserves with SBP down 12 percent to $14.1 billion). These pressures have persisted leading to the adjustment in inter-bank exchange rate during December and this movement in the exchange rate is based on demand and supply of foreign exchange in the interbank market, as per the SBP. Despite the devaluation, the SBP is of the view that Pakistan’s economy is well positioned to achieve the real GDP growth target of 6 percent in 2017/18.
Moody’s, in a report released on January 9, said that allowing the rupee to move in line with the market would be beneficial for the economy as it will help reduce the drain on foreign exchange reserves and enhance the country’s capacity to absorb external shocks.
Moody’s is further of the opinion that as long as inflation expectations are contained, currency flexibility would also enhance Pakistan’s price competitiveness, given the current overvaluation of the rupee.
The International Monetary Fund (IMF), in its country report published in July last year (when dollar was trading at around 105 rupees), had stated that on the basis of real effective exchange rate gap, the rupee was overvalued in the range of 10 percent to 20 percent and had suggested exchange rate flexibility, which the government has finally shown. The much awaited currency devaluation in December was a key event, which has happened and will serve to partially strengthen the country’s external account.