Currency outlook

The IMF’s latest country report has a special focus on external account assessment within its emphasis on the exchange rate to act as a buffer for shocks and emphasizes refraining from restrictions on any imports. The report also mentioned that the removal of import restrictions would likely require additional real depreciation.

In another place, it was acknowledged that the authorities have been proactive in their intent to phase out distortive measures, but there is still space for additional reforms.

The IMF is showing concerns about Fx interventions and lower reserve levels and stressed that it is imperative to avoid any actions to manage the current account, which could lead to excessive appreciation.

At another place, the IMF is saying that external competitiveness remains challenging, as the REER has crept back amid recent nominal stability.

The reading between the lines is there could be prior action of exchange rate adjustment and/or removing distortions in payments. Recently, Egypt did adjust its currency and hiked interest rates just before securing the IMF deal. It’s a known fact that there are prior actions before securing any IMF program, and currency depreciation can be one in the case of the upcoming Pakistan program.

BR Research has reached out to multiple treasury offices of banks, and almost all are interpreting that the currency may adjust by a few percentage points before signing off on the new program.

They all acknowledge that the SBP asks them to manage their payments (outflows) from their respective inflows. And even after the formation of the new system of trading, the invisible hand of SBP is very active. However, they all say that demand is down and almost all the goods import payments are managed through inflows. But they all have pending dividends and other payments.

The question is whether the exchange rate will depreciate before the IMF’s next program and by how much.

“History suggests that this (exchange rate adjustment) would happen, as a prior action. However, there is so much demand destruction and import compression is genuine and seeing that currency may depreciate by 1-2 percent and that is not even called for”, candidly said a treasury head of a bank.

The banker is on a foreign client visit and expects hot money to pour in soon to clear the pending dividend and contractual payments which are estimated between $1-5-2.5 billion.

However, another big bank’s treasury office head has a different view. He thinks that the hot money guys may ask about unwinding restrictions before taking a sizeable bet. Then long-term investors (like Saudis) have concerns about the pending dividend repatriation of foreign investors and are demanding preference in payment. His view is that import restrictions are a ticking bomb for inflation, and the sooner these are removed better it is.

“Now stabilization is done, it’s time to unwind the payments”, he emphasized. “If PKR/USD goes to 290-300, it’s not a big number in percentage terms, and may help to attract inflows which would help the Fx reserves to grow”, he rightly so pointed out.

Another seasoned treasury officer echoed the sentiments. “IMF wants us to move to normalcy, which can only be achieved by SBP’s Fx reserves building. That can only happen if we keep REER as export-friendly (around 90-95). This would open floods of inflows which would help reserves to build which would, in turn, give room to relax administrative measures”.

He further added that with REER at 104, we are running import-friendly policies which are being controlled through administrative measures. This policy has resulted in attaining nominal stability in the exchange rate and helped in bringing inflation under control.

“With stabilization in sight and better inflows, it’s time to relax the administrative controls”, he added. “However, it should be done gradually, and bring REER to export-friendly levels.”

“I think SBP has the realization of the IMF demand and are lately allowing us to partially release our pending dividend payments – we have made around 20-30 percent of 2023 payments recently”, told another large bank’s senior executive.

The general view is that SBP should let the pending dividend and other payments clear and should focus on building reserves by keeping the currency a bit undervalued. However, all are of the view that any sharp movement in the currency could jeopardize stability.

Thus, the currency perhaps may depreciate by 5-10 percent before July and the decline in interest rates would be much slower than the rate at which inflation falls.