Except for a short period, the erosion of foreign exchange reserves has been an overriding feature of the current fiscal year even to the fag-end of it. In recent days, liquid foreign exchange reserves declined by $65 million between May 13 and June 3 - the main reason being surging import bills as it had been throughout the year.
The erosion of foreign exchange reserves in monetary and inflation context has its own implications. On the positive side, it helps reduce/arrest monetary expansion and contributes to deceleration in inflation as lower money balances are available to chase existing stock of goods, which may have been augmented amid increasing imports. Though it would depend upon the nature of goods imported (consumer, consumer durable, raw materials or capital) and the weights assigned to them in the CPI.
Remember when economic agents in the private sector buy foreign exchange from the central bank they pay in local currency to it, which once paid back to the central bank, gets extinguished with it because the cause of original expansion (build-up of reserves) no longer exists. However, if the erosion takes place on account of government, whether for increased imports or in payment of old foreign debt, the decline in reserves may not cause a matching reduction in the existing stock of money supply.
In the purchase process, the government would also pay in local currency asking the central bank to debit its deposit accounts with it. The comparable reduction in government deposits would push up existing level of government budgetary borrowing from the banking system. So, there would be no reduction in money supply if the erosion takes place on account of government.
On the other hand, declining forex reserves send a message to the market about the relative future strength of the local currency and the likely speculative activity on it leading to a possible depreciation of the currency depending again upon the degree of comfort the central bank feels about the adequacy of the forex reserves. The depreciation of local currency may push up prices of imported goods rather instantly and, over time, of domestic goods as well.
The story of the erosion (spread over some nine months) and of the build-up (during March and April) during FY06 goes like this.
The year started with a decline in forex reserves, which continued unabated week in and week out. The result was that between July 1 and November 30, 2005, reserves dipped from $12,623 million to $11,341 million - a decline of $1,282 million in just five months.
After an erratic trend in December, the reserves declined by another $182 million between last December-end and end of February 2006 to reach to another low of $11,505 million. So during the first about eight months and in May 2006, the changes in reserves largely indicated that outflows were larger than inflows although the main sources of inflows - monthly export receipts and remittances, had been generally higher than in the previous year. Though payments on account of past foreign liabilities cannot be ruled out, the main factor behind the erosion of reserves was ever increasing imports.
Overall trade imbalance during FY06 to April 2006 reached $8,427 million - the lowest of $727 million and $808 million being recorded in July 2005 and April 2006, respectively. The 10-month imbalance of $8.4 billion during FY06 so far compared with the whole year imbalance of $6,207 million in FY05. By the end of the year, it appears, it might reach well nigh $10 billion or even higher. This, in a way, can also be said to be cost of whatever reduction in inflation we have achieved so far.
March 2006 was, however, characterised by a rise in reserves reaching $12,487 million by the end of the month, a rise of nearly $1 billion in a matter of 30 days. It was not because of any shrinking of imports, but because of the inclusion of the proceeds of sovereign dollar bonds worth $800 million received in the last week of March. It was a debt-liability with budgetary benefits for the government, but would increase debt-service liabilities in future. The erosion started again in April with reserves declining to $12,402 million on April 8, the country losing $85 million in just one week.
Thereafter, it is a story of rising reserves driven by privatisation proceeds, mainly of PTCL, with reserves crossing the $13 billion mark on April 29 and reaching an all-time high figure of $13,070 million two weeks later.
At $13,006 million (SBP: $10,578.5 million, other banks: $2,427.3 million) on June 3, 2006, the reserves though lower by $1 million over the previous week, were still above $13 billion mark for the sixth week in a row. How do we manage to maintain the $13 billion level will be unfolded in the coming weeks?
Among other developments, overall government borrowing during the year to May 27 amounted to Rs 72.6 billion (budget: Rs 66 billion, commodities and others: Rs 6.5 billion with wheat procurement loans roughly amounting to over Rs 43 billion between April 22 and May 27).
The private sector credit rose again to Rs 343 billion (commercial banks: up Rs 361 billion, specialised banks: down Rs 17.6 billion) on May 27 after decelerating to below Rs 340 billion during the last two weeks from a high of about Rs 346 billion on May 6. Notwithstanding these expansions in credit, the contraction impact of other items (net) or OINs of the banking system of some Rs 95 billion on May 27 depressed overall domestic credit expansion to Rs 321 billion as on that date.
Read with foreign sector's (or NFAs') expansion impact of about Rs 41 billion on May 27, lower than of Rs 45 billion the previous week, overall money supply during the year so far rose to 362.5 billion compared with Rs 378 billion in the corresponding period of FY05. The targeted expansion of money supply for the whole of FY06 is Rs 380 billion.
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