Political stability critical to attaining sustainable external account stability

The State Bank of Pakistan (SBP) has managed to maintain forex reserves despite facing substantial debt servicing payments. This indicates that the SBP has been actively purchasing dollars from the interbank market, a positive move.

However, it’s crucial to note that this doesn’t necessarily indicate readiness for economic growth or currency appreciation. The key lies in ensuring that the SBP’s forex reserves are sufficiently built up, which, even now, do not cover more than two months of imports.

Reportedly, the SBP has purchased approximately $5.5 billion on a gross basis in the current fiscal year from the interbank market. Some experts suggest that if the SBP hadn’t bought dollars, the PKR/USD exchange rate could have appreciated to levels between 235-245.

A similar analysis is based on the cumulative inflation differential between Pakistan and the US over the last three years. For instance, Pakistan’s Consumer Price Index (CPI) rose by 84 percent, while US inflation increased by 18 percent since March 2021. Based on these numbers, the implied PKR/USD value stands at 243, up from 153 in March 2021.

Unfortunately, economics is not a precise science where inputting values into formulae yields a unique solution. It is a social science, and multiple factors determine currency parity, including political stability and economic confidence.

SBP’s gross purchases of $5-6 billion in FY24 are not substantial. Firstly, it’s a gross figure, and secondly, the SBP is responsible for government debt principal and interest payments. It must either replenish reserves through incremental borrowing or purchase from the interbank market when reserves are critically low.

The primary income debit within the current account amounted to $6.1 billion in 9MFY24. This mainly includes government debt interest payments and private sector dividend, interest, and profit repatriation. Assuming government debt of approximately $100 billion and an average interest rate of 5 percent, payments in nine months are estimated at $3.75 billion. Thus, out of the $5.5 billion SBP’s purchases, $3.75 billion goes towards servicing government debt.

Additionally, the SBP could have used these purchases to reduce forward/swap liabilities, which have decreased by $1.1 billion this year.

Looking at SBP’s gross purchases as a percentage of forex inflows - exports (goods and services) and remittances - is another perspective. These inflows amounted to $51 billion in 9MFY24, so buying 10-12 percent should not be a cause for concern.

Apart from market purchases, the SBP uses the government’s fresh debt to fulfill its obligations. Since overall debt has increased marginally, the SBP has used market purchases to meet its obligations.

Had the SBP not bought dollars, banks could have used the surplus to clear the backlog of dividend payments, profit repatriation, contractual payments, and payments due to Chinese IPPs (independent power producers). Consequently, SBP’s forex reserves would still have been close to $4 billion.

Throughout the year, SBP’s market purchases were not excessively high but necessary. It could not have allowed the currency to appreciate, as it would have led to reserves falling below one month of import cover. Furthermore, market dynamics would have depreciated the currency well beyond 300.

The key lies in building forex reserves and running a surplus balance of payments - achieved through either a current account surplus or a financial/capital accounts surplus, or a combination of both.

Ideally, a healthy current account deficit financed by investment and debt would spur growth. However, Pakistan doesn’t attract the same interest as neighboring India. Hence, reliance on the IMF and other partners (often with political strings attached) to maintain a surplus current account is necessary.

A critical point to note is the capital flight from Pakistan over the last two years, exacerbating the situation. Import compression policies had to be implemented to counter this. Pakistan’s home remittances have decreased from $23 billion in 9MFY22 to $21 billion in 9MFY24.

Interestingly, the decline of $2 billion is largely from GCC countries. This is counterintuitive, considering around 1.5 million Pakistanis have left to work abroad, primarily headed to the Middle East. Remittances should have increased, but they have decreased by double digits - the biggest decrease being 19 percent from Dubai.

One could assume that reduced inward remittances offset capital flight. Many wealthy individuals this writer has spoken to have sent substantial savings abroad over the last two years, fearing economic default and socioeconomic deterioration. The heightened fear and risk stem from political uncertainty, which has a more significant impact on ground realities than fair values based on economic fundamentals.

Authorities in the countryhave failed to acknowledge that political chaos is leading to the economic challenges we face today. This impedes our ability to build reserves and attract investment that could lead to currency appreciation.

Had remittances increased by $2-$3 billion this year, the SBP could have used purchased dollars to build reserves or clear pending private payments. Both scenarios could have bolstered confidence, and confidence is crucial for stability in the economy and the currency at this time.

Copyright Business Recorder, 2024