Depreciation of the rupee

The Pak rupee or PKR has been losing ground against major international currencies in the recent past. On 7th September, it fell to a record low versus the US dollar, losing 17 paisas for buying at Rs 86.01 and 18 paisas for selling at Rs 86.06 in the interbank market.
According to currency dealers, the surge in the dollar value was mainly due to heavy demand for foreign exchange for making payments for the import of crude oil and the greenback was expected to appreciate somewhat once the pressure for payments eases to previous levels.
The value of the rupee, however, remained firm in the open currency market where it was traded between Rs 85.20 and Rs 85.50 to a dollar, due largely to heavy inflow of remittances usually witnessed towards the end of the month of Ramazan when expatriates remit larger amount of foreign exchange to meet the needs of their family members back home.
Going by the trend in the previous years, the rupee could also lose its value in the open market after Eid-ul-Fitr. So far as the overall trend was concerned, although rupee parity would continue to change according to market conditions, due to a flexible exchange rate policy of the government, the Pak currency is likely to experience further erosion in its value, both in the interbank and open markets, in the coming period.
Pressure on the rupee seems to have emanated primarily from the strength of the US dollar in the international money market and the growing weakness of the economy of Pakistan. The euro, for instance, has fallen to about US $1.28 due to the rekindling of worries about the European banking sector, which has prompted investors to cut risks.
The economy of Pakistan, which was already in poor shape and depended heavily on foreign loans and assistance to maintain solvency, has been devastated by the recent floods and is expected to take a long time to recover from this deadly blow. Although the precise impact of the recent floods is yet to be calculated, but there are clear indications that the growth rate during FY11 would be much lower than projected, the budget deficit would deteriorate further and the inflation rate could be double the target of 9.5 percent.
Worsening of these variables would put further pressure on the rupee, though the extent of depreciation cannot be predicted at this point of time due to obvious reasons. Authorities of the country, however, would need to study the situation carefully and refrain from taking hasty or politically motivated decisions for ensuring stability in the exchange rate on a long-term basis.
Half the battle could be won by persuading the people and political leaders that a particular level or rigidity in the exchange rate of the rupee is not a matter of prestige and adjustment in the rate, if any, reflects only a change in the fundamentals of the economy. Therefore, the rupee has the chance of appreciating to its previous levels, once the economy is able to recover and regain its strength.
Any artificial support or reverting to a fixed exchange regime could prove counter-productive. Fortunately, the economic managers of Pakistan are themselves fully convinced about this particular aspect and have allowed the rupee to find its own value in the international money market through the free inter-play of market forces. Hopefully, the policy of the free-float of the rupee would be maintained, whatever the compulsions.
Such a policy would, over time, serve to narrow the current account deficit and help in maintaining foreign exchange reserves and the rupee rate at a reasonable level. Positive actions in three other areas could also support exchange rate stability of the Pak currency. Firstly, the temptation to ease fiscal and monetary policies during the crisis triggered by the floods must be avoided at all costs.
Secondly, a proper understanding with the IMF is a must to cultivate credibility in the international circles about the sound management of the economy. Presently, there are certain problems in the disbursement of the last two tranches of the current SBA due to the non-observance of the performance criteria, but both the Pakistani and Fund authorities need to realise the gravity of the situation and come to a proper understanding soon.
And lastly, the present facilities available to the expatriates for home remittances under the Income Tax Ordinance need to be retained to bridge the gap in the external sector. Withdrawal of these facilities, as proposed in a recent study by the FBR, could reduce the amount of home remittances through proper channels and add to the pressure on the rupee in the interbank market.