The budget for the current fiscal year, reviewed and amended by the International Monetary Fund (IMF) as a prior condition for the staff level agreement (SLA) on the Stand-By Arrangement (SBA) reached on 29 June 2023, projected an exchange rate of 284 rupees to the dollar (average of 1 July 2023 to 30 June 2024) while the SBA documents uploaded on the Fund’s website mid-July 2023 set the exchange rate at 286.7091 (a nine month programme scheduled to end in April 2024).
The rupee’s present external value is lower than what was projected in the budget and the SBA documents, which could have raised some red flags with the IMF but did not as is evidenced from the fact that the first staff review was successfully completed on 15 November 2023 (the rupee dollar parity that day was 287.2), which led to the IMF executive board approval, a prerequisite for the release of the next tranche, on 11 January 2024 (287.73 to the dollar) and the Fund uploaded the documents of the first review on 19 January 2024 (the rupee further weakened to 279.25 to the dollar).
While the rupee has been relatively stable since January this year yet on 7 September 2023 the rupee-dollar parity was alarmingly at 306.95 rupees, prompting the stakeholders to initiate punitive action against speculators as well as initiate structural reforms in the exchange companies sector which successfully strengthened the rupee.
This was emphasized in the Letter of Intent (LoI) submitted to the Fund dated 18 December 2023, a prerequisite for Board consideration of tranche disbursement, signed off by the caretaker finance minister and Governor State Bank of Pakistan: “on the average, premium between the interbank and open market exchange rate was missed from mid-August to early-September, due in part to speculative activities and illegal trading.
To ensure compliance going forward, we have initiated structural reforms in the exchange companies sector that will enhance governance and transparency, and are fully committed to build reserves as conditions permit and letting the rupee find its market value as imports are normalized even if pressures re-emerge.”
IMF staff’s comment on the parity was noted in a footnote: “Pakistan maintains an exchange restriction resulting from the limitation on advance payments for imports against letters of credit (LCs) and advance payments beyond the certain amount per invoice (without LCs) for the import of eligible items (imposed in 2018).
At the time of the SBA request the IMF Executive Board approved the exchange restriction for the duration of the programme.”
The scheduled end of the SBA is 12 April 2024 but all stakeholders are agreed, in and outside country, that there is a need to immediately seek another longer term programme to avert the possibility of default and therefore there is every likelihood that the next programme would require ending all import restrictions as an upfront condition at worst or the new government maybe provided a reprieve till the end of the current fiscal year on 30 June 2024.
This may, if past history is anything to go by, raise the possibility of resurfacing of a disturbing current account deficit.
The transition to a market determined exchange rate was the outcome of SLA reached on 12 May 2019 that led to approval of a three-year Extended Fund Facility (EFF) programme. A market determined exchange rate is not defined by the IMF as a free float which is followed only in countries with hard currencies (dollar, pound, Euros) but as a managed float with no predetermined path for the exchange rate though it is allowed to fluctuate within a monetary policy framework inclusive of establishing floors for international reserves, ceiling for net domestic assets and foreign exchange reserves.
Or in other words, the State Bank can take an informed decision based on key macroeconomic variables if members of the executive do not exert undue influence.
The pledge to adopt a market determined exchange rate was not violated for three years in spite of the onset of Covid 19 early 2020, the summary dismissal of Hafeez Sheikh in March 2021, his replacement by Shaukat Tareen, followed by a change in government in April 2022 and the appointment of Miftah Ismail as finance minister.
However, Dar’s tenure as Finance Minister is exemplified by artificially strengthening the rupee value - a policy in effect from 2013 to 2017 that led to a verifiable major detrimental impact by mid-2018 notably the highest-ever current account deficit of 20 billion dollars in the country’s history.
Dar’s reappointment as finance minister on 27 September 2022 till August 2023 with carte blanche to formulate policy that few of his predecessors or successors have enjoyed (though he was effectively barred from taking any policy initiative as soon as the SBA was signed) led to the implementation of the flawed policy of artificially controlling the rupee dollar parity that cost the country severely: (i) 4 billion dollar fall in remittance inflows through official channels (as Pakistanis restarted remitting through the illegal hundi/hawala system with the emergence of multiple exchange rates with at one time a 35 to 40 rupee per dollar differential between official and hundi/hawala rates on offer), (ii) a disincentive to exports (more than offset by the 110 billion rupee electricity subsidy to exporters that Dar announced on 6 October 2023), (iii) foreign exchange reserves plummeted and reached a low of under 3 billion dollars not enough to meet even a week’s worth of imports; and (iv) the country struggled with a negative inflow of foreign assistance due to suspension of the EFF by the Fund, which raised the specter of default.
Fund staff in the first SBA review report argued that a market-based exchange rate is a measure that is critical to restoring public trust in the exchange rate system. Recent reports indicate that the premium for two months of forward selling is as high as 8 rupees per dollar with exchange companies halting the sale of dollars and this in spite of the rupee-dollar parity fluctuation within a very narrow band since January this year.
This, in turn, may legitimately raise IMF’s hackles and jeopardise the success of the final SBA review — a toxic legacy of the caretakers to the Shehbaz Sharif-led government.
In the event that the IMF is convinced that the external rupee is being artificially controlled again, though this has not resulted in any significant dampening of inflation, the success of the final SLA may be jeopardised with a consequent cessation of pledged assistance by other multilaterals and friendly countries with as disastrous consequences as during the Dar months from end September 2002 till June 2023.
To conclude, one would be compelled to maintain that given the plethora of economic issues the country is facing today the market based exchange rate must be allowed to prevail by the elected government or else the looming threat of default will resurface.
Copyright Business Recorder, 2024
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