Is the rupee poised to depreciate?

BUSINESSMEN and investors want to know how long the rupee may remain stable. Many fear that the local currency might lose its worth against the mighty US dollar in the coming weeks and months.

The State Bank of Pakistan (SBP) doesn’t have enough foreign exchange reserves to cover even two months of import bills for goods. This means that the rupee will start losing ground whenever market-driven demand for the dollar spikes. And the dollar demand may spike soon as the SBP further liberalises import payments and outward remittances pick up further pace.

So far, the SBP has successfully saved the exchange rates from the speculative attack on the rupee, thanks to the strong backing of the country’s powerful establishment. It may continue to avert speculative attacks on the rupee in future as well. However, the central bank or the incoming government cannot do much when the real demand for the dollar increases sharply and the supply cannot match it.

The last tranche of the International Monetary (IMF) Fund’s $3 billion short-term loan is expected in April. Between now and the end of March, the external debt servicing will have to be financed without the IMF money. That, combined with increased import payments and other regular outflows of foreign exchange, may bring the rupee under pressure. A newly formed weak coalition government and our central bank with low forex reserves may find it too hard to manage that pressure effectively.

A newly formed weak coalition government and low forex reservesith the central bank will make it challenging to manage the pressure on the exchange rate

During seven months of this fiscal year, between July 2023 and Jan 2024, Pakistan’s goods imports consumed $30.95bn, whereas exports fetched only $17.78bn, according to the Pakistan Bureau of Statistics. That left a huge trade deficit of $13.17bn. Luckily, home remittances during this period ($15.83bn) outweighed this deficit. Had this not happened, the rupee would have been under immense pressure.

However, the main contributor to shrinkage in the trade deficit was a decline in import bills from $36.03bn in seven months of the last fiscal year to $30.95bn. An increase in export earnings — from $16.48bn in 7MFY23 to $17.78bn — played a lesser role.

Regardless of who will be part of the coalition and who will sit on the Opposition benches, the incoming coalition government in Islamabad will understandably try to help revive industrial output and remove supply obstacles through further import liberalisation on the lines of the IMF prescription for the ailing economy. A new coalition government will otherwise find it too difficult to say ‘no’ to the IMF’s demand for it.

The new government (which is yet to be formed but will hopefully be formed by the end of this month) may also like to ensure the continuation of growth in exports. But the ever-growing cost of energy (don’t forget the recent rise in gas, electricity and fuel oil prices), high interest rates, political polarisation and ongoing protests condemning “vote rigging” and “election engineering” will make it too difficult. This means the trade deficit may not shrink as fast in the coming months as it did earlier. Home remittances may well take care of the deficit, though.

That may help only to the extent that the rupee may lose its strength gradually and slowly, or in the best-case scenario, it may remain stable for a while. But the best-case scenario refers to the materialisation of the promised foreign investment from the Gulf Cooperation Council (GCC) region and a solid thickening of regular net inflows of foreign investment from around the world.

Both seem to be distant possibilities, at least till the end of this fiscal year in June. Foreign investment from GCC will start trickling in only after Saudi Arabia, UAE, and Qatar gather enough practical evidence that the new government is capable of and willing to follow up the investment deals signed during the caretaker setup under the umbrella of the Special Investment Facilitation Council.

Net foreign private investment, including foreign direct and portfolio investment, totalled just $933.5 million in the first six months of this fiscal year. Though even at this level, the amount is 49 per cent more than what was received in the year-ago period, it is insubstantial compared with the large balance of payments deficit (BoP). In the first half of this fiscal year, Pakistan’s BoP deficit stood at $3bn, according to SBP.

Attracting foreign investment from the West may be even harder than the GCC as the US, EU, and UK will closely watch Pakistan’s fresh positioning and posturing in geopolitics under an elected government. Much also depends on how soon the incoming government goes to the IMF to negotiate a large, long-term loan.

Pakistan’s external financing gap for the next two fiscal years is no less than $50bn, and closing this gap is not possible by avoiding the IMF. Chances are that the incoming government will engage with the IMF sooner than later.

Meanwhile, external debt servicing will continue to exert pressure on the exchange rate even if Pakistan manages to secure rollover of the special debts it secured in recent years from three friendly countries: China, Saudi Arabia and the UAE.

In six months of FY24, Pakistan spent $3.54bn on principal repayment of old foreign debts, and it also had to dish out an additional $2bn in interest payments. With the stock of foreign debt growing, Pakistan’s foreign exchange needs for external debt servicing may continue for a long time to come.

The country’s total outstanding foreign debt and liabilities rose to $131.2bn in December 2023 from $128.6bn in December 2022, according to the latest SBP stats.

Pakistan’s weak external economy requires the restoration of political stability in the country. Without this, no big foreign investment may come in, no major export-boosting initiatives can work, and not even overseas Pakistanis can be convinced to send more foreign exchange back home.