A drifting economy

It is quite distressful to see the nascent economic recovery ceding way to the same uncertainty and drift that existed during the month of July. Although the stock market continues to rise, the forex market until a few days ago looked set to face the same turmoil it witnessed last month. It was happening despite near certainty regarding the release of the delayed tranche from the IMF (International Monetary Fund).

From about Rs 240/$ on 1st August, the weighted average customers exchange rates came down to about Rs 214/$ by 16th August, and then the trend reversed suddenly and on 29th August it climbed to Rs 222/$. A more worrying trend has been observed in the open market. The corresponding rates in the open market were 211/$ and 232/$ with a constant difference of Rs 3 in the buying-selling rates. What is the economic cause behind such disruption and such a large disparity between inter-bank and open market?

Before we reflect on this, let us recognise the remarkable development in the market after the news of release of IMF tranche was received. There was a drastic change in the market sentiment. The rupee strengthened by Rs.8 in the open market from Rs 232 to Rs 224 while in the inter-bank market it improved by Rs 2 from Rs 222 to Rs 220.

To understand the causes behind this disruptive change, let us see whether any new economic information contributed to this negative sentiment? Two important results have emerged during this period. First, the balance of payments (BoP) data for July 2022 was released on 24th August and it led to partial dilution of the feel good factor contained in the trade data released earlier by the Pakistan Bureau of Statistics (PBS).

The BoP data showed the current account deficit (CAD) at $1.2 billion, which is significantly higher than what one expected based on PBS (Pakistan Bureau of Statistics) results and also was higher than the $851 million in July 2021, a 42% increase even though the July 2021 CAD had set the pattern for a very high overall CAD for FY22. Two factors are behind this development.

First, BoP imports are higher by $300m compared to PBS whereas the remittances were also down by a similar amount. Regarding higher BoP imports, it seems payments for some of the imports of June were made in July, which also caused the July disorder in the market. Exports were slightly better than in July 2021.

The CAD for July is quite elevated. At this rate, the end year CAD would be $14.4 billion, or nearly 4% of last year’s GDP. This would continue to pose external account challenge for our economy which cannot be risked after we have hardly overcome the difficulties of last year. The imports require further pruning while remittances have to be kept minimum at last year’s level.

Second, the weekly price indices released in the last three weeks should be a cause of great concern. During the weeks ending on 11-8-2022, 18-8-2022 and 25-8-2022, prices on week-on-week basis increased -0.08%, 3.35% and 1.83%, respectively, which are quite high. Also, the prices on week-over-the-week-last-year basis increased 38%, 42% and 45%, which are unprecedented. These inflationary prices are not going to abate anytime soon.

Regarding the differential between inter-bank and open market, there are all sorts of rumours circulating in the market. It is said that the demand for dollars from Afghanistan has been exceptional. The shortage of dollar currency notes is also reported.

It is quite intriguing that on 17th August 2022, the State Bank of Pakistan (SBP) took an unprecedented step to allow export of dollars on consignment basis on the plea of exchange companies with the condition that these would be repatriated within three days into their approved accounts and made available to the inter-bank market.

It is incumbent on the SBP to examine this issue and ensure that its facilitative action has not been abused and reported shortages of dollar bills are effectively addressed. In sum, we don’t see these pieces of information, though a bit concerning, can form the basis or explain the recent turmoil in the forex market.

However, it was quite surprising that during this period there was no attempt by relevant entities to guide public sentiment or explain the causes behind such untoward activity in the market.

The Acting Governor of SBP has spared no opportunity to underline the fundamental fact that Pakistan has lined up $36 billion financing against its needs of $32 billion, implying a reserves build-up of at least $4 billion at the close of the year. So, from where is the need for continuing adjustment in exchange rate coming? We believe there is no basis for exchange rate volatility and strong oversight on market practices should be exercised and speculative tendencies should be curbed to help stabilize the market.

Although the revival of the IMF programme would boost market confidence and strengthen the position of economic managers, a more ominous threat to economic stability is brewing in the wake of floods which have inundated about one-third of the country.

The reported losses, though still very tentative, are colossal, incurred both in terms of lives (1100), crops (50% cotton crop damaged and generally a large part of farmland is under water), property (one million housing units destroyed and one million livestock swept away) and infrastructure (thousands kilometers of roads and bridges washed out). The Finance Minister has indicated a loss of $10 billion, which is close to 3% of GDP. Undoubtedly, this is a calamity previously unknown to the country. This would pose real danger impinging on the medium-term economic outlook of the country.

Some of the implications would include rising import demand both to meet food related shortages (wheat) and cotton to allow the industry to meet the crop shortfall. Therefore, as noted earlier in BoP discussion, the external account would come under pressure. Additionally, there would be new expenditure needs, first, to support rescue and relief operations and, second, to undertake rehabilitation and reconstruction activities. Clearly, taken together, both these pressures will adversely affect the performance under the Fund programme.

The government should initiate a dialogue with its development partners and seek concessions exclusively related to contingencies emanating from the floods. It would be fair to expect a positive response as the country received during the COVID-19 pandemic. However, we should be prepared for a couple of years of austerity and no growth, which would contribute to poverty and unemployment. This can be mitigated to some extent by significantly expanding the social safety net programmes such BISP (Benazir Income Support Programme) and launching special programmes for the people affected by floods.

Copyright Business Recorder, 2022