Currency – snowballing?

A negative feedback loop reigns over the currency market, creating a snowball effect. This is why investor confidence and sentiment is just as important in economic management as strength of fundamentals. Political instability has resulted in the downgrading of rating by Fitch. Stock market has tanked too. Yesterday, Pak Rupee slipped to 222 against dollar. The government watches on like a silence spectator, unable to arrest the freefall. Who is to take the onus of economy in these extremely difficult situations?

With Punjab handing a landslide victory to PTI in the by-elections, markets confidence on the PDM government is fast eroding. Market players are skeptical about government’s ability to act on Fund’s stringent conditions, imperative to help Pakistan fetch $1.2 billion.

Government needs to stand firm on its commitment to rationalize the electricity and gas tariffs as agreed with the IMF. This should be done immediately to calm market sentiments. Otherwise, this freefall could prepone the catastrophe which is still very much avoidable. Once the volatility ends, the free fall will stop. The government should immediately engage friendly countries to get commitments of $4 billion which is also a pre-condition for the IMF. Money can come later but assurance must come now. For that to happen, domestic political bickering needs to calm down.

The problem is that government’s sole focus is to salvage Punjab through breaking votes of PTI and allies. The effort is to save the weak coalition government in the province. The economy has been placed at the back burner. Time is fast running out for PDM. The finance minister needs to have the power and backing of the government to do so. That is missing. It is unclear whether the government will stay on for long enough and whether it can put into action plans agreed upon with the IMF.

What happened in the currency market over the last two days is not purely demand and supply. SBP has buffers to withstand the pressure for couple of months. However, the institution is extra conscious in deploying its ammunition to even fulfill its explicitly stated objective of curbing disorderly movement. Fall of Rs11 against dollar in just two days is certainly not orderly. SBP is looking towards Q block to take the lead. Q Block in turn, has eyes set on party leadership in Lahore, which is busy consulting with coalition partners, who are perhaps waiting for the nod by of supreme leadership in London. The political chain of command has become too complicated in days when urgent action is needed. Equation is becoming even harder to solve without taking algebraic variables X, Y and Z into account.

The payments pressures do not permit allowing the currency to enter freefall. And no fall in the currency is enough to generate flows. SBP is saving its reserves to avert default. Banks do not have much to deploy. Foreign money usually stays away from crippling economies. Confidence must be restored immediately. Islamabad needs to wake up and smell default!