Analysts weigh in: rupee’s latest depreciation has wider implications, outcomes

The rupee depreciated a combined 12.1% over the course of two days, after a free-floating exchange rate kicked in on Thursday. The development narrowed to an extent the gap that existed among the inter-bank, open- and black-markets of foreign currency that had crossed Rs25 in the last few months.

Amid this turmoil, Business Recorder takes a look at the wider implications of the move, which was largely made to meet a key prior condition of the International Monetary Fund (IMF) that said its mission will visit Islamabad at the end of January to continue discussions under the ninth Extended Fund Facility (EFF) review.

Pakistan is desperately looking to revive its IMF bailout programme amid fast-depleting foreign exchange reserves that plummeted to $3.7 billion, according to latest data.

LC issue and containers stuck at ports

Speaking to Business Recorder, Pak Kuwait Investment Company Head of Research Samiullah Tariq stated that following the depreciation, imports are expected to be cleared from the ports.

It is pertinent to mention that several import containers are awaiting clearance as banks refused to retire letters of credit (LCs).

“Now that the rupee-dollar parity has achieved equilibrium, banks should begin to retire the LCs,” he said.

“Therefore in the short run, imports are expected to rise because some essential items became short in the market due to import restrictions.”

Earlier, Business Recorder reported that the country was on the brink of shortage of X-ray, CT and MRI films. Even the pharmaceutical industry was perturbed over its inability to import raw material as banks failed to open LCs because of dollar shortage.

“Moreover, since the import containers at the port will now be cleared, there will be a huge inflow of imported material in the market,” Tariq added.

He was of the view that banks will begin to open LCs for new imports gradually.

“All this is expected but we have to wait and watch,” he said. “However, in the longer run, once supply chain normalises, imports are expected to decline.”

Alpha Beta Core CEO Khurram Schehzad echoed similar views and told Business Recorder that the recent depreciation in rupee will shrink imports.

Ismail Iqbal Securities Head of Research Fahad Rauf told Business Recorder that “imports are administratively managed”.

“Given the upcoming spike in prices of imported merchandise, their demand will fall which will bring a partial decline in imported materials in future,” said Rauf.

Remittances are expected to rise later as the gap between the prices in illegal channels of transferring money and legal channels is decreasing so ultimately people will choose the legal channel: Head of Research at Ismail Iqbal Securities Fahad Rauf

Exports and foreign exchange reserves

All three analysts predicted an increase in exports.

Schehzad said exports proceeds are expected to improve by at least $500 million in the next few months against the numbers of last two months.

“These potentially improved inflows due to currency adjustment (and rerouting of flows from Hawala market) should be able to support country’s foreign exchange reserves and therefore stabilise the currency parity,” said Schehzad.

Tariq also foresaw a “slow and gradual” increase in exports.

Rauf stated that in the medium-term, exports will become price competitive therefore, they are expected to increase.

In the short-run, export orders that were facing delays will be cleared so there will be a short-lived spike, he said.

Remittances

Speaking about the impact on remittances, Rauf stated that over the past few days, foreign inflows have inched up but “the number is not unusually high”.

“However, remittances are expected to rise later as the gap between the prices in illegal channels of transferring money and legal channels is decreasing so ultimately people will choose the legal channel,” he said.

Tariq also predicted remittances to rise.

Schehzad said that “as per the updates from formal channels, a substantial flow of remittances has started flowing in back through the formal channels.

“Remittances are expected to cross $2.5 billion per month to gradually reach close to $3 billion in the coming months,” he added.

Inflation and interest rate

However, all analysts sounded an alarm over the expected increase in prices of commodities following a spike in value of dollar against the rupee.

Rauf told Business Recorder that inflation will be led by surge in prices of imported commodities, primarily oil.

“The current rate of petroleum commodities was calculated at Rs225 per dollar but within a fortnight, the new rate will be calculated at over Rs250 per dollar,” he said. “This will cause a surge in the inflation number for February.”

Rauf was unsure whether inflation will steer an increase in interest rate or not but he stated that market yields are currently at 18% “meaning that the market is expecting another 100bps increase in interest rate”.

Tariq admitted that inflation will rise but the State Bank of Pakistan (SBP) was not expected to raise the interest rate.

“However, if inflation rises past the central bank’s expectations, then it will be left with no option but to increase the policy rate,” he said.

Schehzad was of the view that spike in inflation will cause the SBP to hike the interest rate.

In a report, IGI Securities stated that as the immediate consequence of drop in rupee value, the brokerage house anticipated an increase in prices.

“Essential imports like food and oil will now be sold at higher rates, which, without government intervention, would quickly lead to higher inflation. Assuming all other factors remain constant, the domestic prices of petrol and diesel will rise by an estimated 10% due to the depreciation of the exchange rate.”

“Prices of non-essential items have, to some extent, already been factored in with black market rates.

“In the medium term, the indirect impact of higher energy and other non-essential item prices will be substantial,” it said.

Post official exchange rate the price pain will be inevitable and hence inflation expectation will be high, it said.

“Our initial expectation of rate hike in 1HCY23 was of 200bps, of which 100bps has been delivered. We think the SBP will now need to come more aggressive on rate hikes, as to further suppress demand and anchor down inflation,” the report added.