The sharp depreciation of the rupee in the exchange market seems to have greatly disturbed the authorities. In a meeting with the heads of commercial banks on 9th May, State Bank Governor Shamshad Akhtar warned that the central bank could impose severe administrative controls over the foreign exchange market "if the market fails to discipline itself".
She expressed concern over the excessive volatility and weakening of exchange rate and commented that the recent behaviour of the exchange market was "totally out of line". "We are not in a crisis-like situation, and several measures are in place to remove the macro-economic imbalances".
The market forces are yet to see the new government address the macro-economic imbalances. Except for upward adjustments in the prices of POL products and minor increase in prices at utility stores there has been no positive movement. Government borrowing from SBP has touched Rs 485 billion. Has the government announced any jumbo PIB auction to retire the borrowings from SBP? Budgetary inflows from FDIs, privatisation proceeds from sale of GDRs and bonds is much below the target.
The exchangeable bond has been delayed, despite award of the mandate to a banking consortium. The economic team of this government is pre-occupied with the judicial crisis and castigating the previous government, with the result that no measures to raise resources to reduce the fiscal gap have been announced thus far. Yes, there are reports of delays in making payments to suppliers and contractors. And, deferring expenditure under the PSDP to roll them into the next financial year may help a little in bringing down the fiscal deficit from the estimated six percent of GDP.
But all this will be inadequate. The investor class is worried about wealth tax imposition; capital gains tax on equities and real estate and raising of tax rates on higher bracket incomes. No meaningful measures are in place yet to reverse the growing trade ($16.08 billion in 10 months) and current account deficits. The measures taken to remove the macro-economic imbalances may be known to the SBP Governor but they are certainly not known to the market players or perhaps even the Government!
We understand the concerns of the State Bank about excessive fluctuations in the rupee exchange rate and are also in agreement with most of the observations of the Governor, but the exchange volatility seen lately is an inherent part of the existing forex arrangement of the country. Unlike the past, when the rupee parity was fixed, we are now following the system of a free float. Under this scheme the external value of the rupee is determined freely according to the market conditions and the State Bank can only intervene to influence the market sentiment without dictating the actual rate of its currency.
Some of analysts may disagree with such an arrangement but its logic is so sound that almost all the countries of the world are now following this system and that is why the State Bank often has to explain the rationale of its policy position to the stakeholders. However, while agreeing with the basic policy thrust of the SBP, we would like to state that the recent exchange rate developments, contrary to its assertions, should not be surprising or unexpected for the State Bank.
In fact, these were due for some time and the market has turned out to be wiser than the government and the State Bank bureaucracy. The exchange rate of a country's currency reflects the health of its economic fundamentals vis-à-vis other countries and it cannot expect its currency to remain stable or improve if its economic indicators continue to be relatively adverse. The current year has been particularly unfavourable for the Pakistan economy. For instance, fiscal deficit has soared, current account deficit has reached unsustainable levels, foreign exchange reserves are depleting, inflation, particularly of food items, is almost at a record level, foreign investment has gone down drastically, and GDP growth rate is estimated to be lower than the target.
Uncertainty over reinstatement judges, statements by the Finance Minister about the imposition of wealth and capital gains tax and perceived economic meltdown in case the PPP-PML(N) coalition government breaks down, has added to the panic in the market and resulted in flight of capital. We fail to understand how the authorities expect the rupee to be stable in the presence of all these adverse factors.
State Bank's intervention can slow down the rate of depreciation but cannot alter the basic trend. Policy makers of the country would have to improve the fundamentals of the economy in a significant way and remove the prevailing political uncertainty in the country if the goal of a stable exchange rate is to be achieved. Governor Akhtar has talked about the resolve of the government to improve the twin deficits of the economy, etc but the markets are generally more responsive to the actual developments and give less importance to wishful thinking.
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