Value of the rupee

The SBP has released the estimate of the Real Effective Exchange Rate (REER) Index of the rupee in December 2024. It stands at 103.7, as compared to 103.2 in November. The value in December is the highest since April 2024 when it stood at 104.4.

The SBP has cautioned that the REER index should not be misinterpreted as denoting the equilibrium value of the currency. However, the change in the magnitude of the REER from a low of 85.3 in April 2023 to the recent value of 103.7 must be seen as a clear indication of the strengthening of the rupee.

The rise of the index to above 100 indicates that the rupee has not depreciated enough to reflect the difference between the rate of inflation in Pakistan and the global rate of inflation.

Between December 2023 and December 2024 there has been only a marginal change in the nominal exchange rate. It was Rs 279.18 per US$ in December 2023 and has, in fact, strengthened marginally to Rs 278.12 per US$ in December 2024.

The strengthening of the rupee is attributable to the improvement in the external balance of payments position, which was facilitated by the IMF Stand-by Facility of 2023-24. The foreign exchange reserves had plummeted to only USD 4 billon in June 2023; they rose subsequently to $9 billion by June 2024 and now stand at close to USD12 billion.

The appreciation in the REER is also attributable to the quantum decline in the rate of inflation in Pakistan. It was as high as 28.8 percent in July to December 2023. The last six months it is down to only 7.2 percent.

The last time the REER was significantly above 100 was in 2017-18. The peak value was 107.3 in June 2018. Consequently, exports were uncompetitive due to a strong rupee, while imports had become relatively cheap.

The consequence was a spiraling up of the trade deficit from USD 30.7 billion in 2016-17 to USD 37.3 billion in 2017-18 in goods and services. This led to the largest-ever current account deficit of USD 19.2 billion. Imports, in particular, went up by over 16 percent while the growth in exports was 9 percent.

We have today the happy and unusual paradox of a strong and nominally stable currency and actually a current account surplus. This is in total contrast to the situation in 2017-18, when the REER was also above 100 and the result was an all-time high current account deficit.

The fundamental question is what explains this extraordinarily positive situation? There is need for kudos to the SBP for having successfully maintained the nominal value of the rupee at between Rs 278 and 279 per dollar since March 2024.

This is also contrary to the IMF expectations. Following the agreement on the three-year Extended Fund Facility to Pakistan, the IMF Staff Report of September 2024 contains a different projection of the value of the rupee in 2024-25. It is expected to average at Rs 302 per dollar during the year, implying, thereby, a depreciation in the value of the rupee of over 8%.

Therefore, there is need to explain the surplus in the current account of the balance of payments despite a relatively strong rupee. First, exports have increased by 7% during July to December 2024 due to expansion in market opportunities and better dollar prices.

Exports of rice have increased in quantity by as much as 38 percent due to a bumper crop and the ban on exports of rice by India. Overall, exports of textiles have jumped up by 13 percent, due particularly to better dollar prices, which have preserved the profitability of exports, despite a nominally stable rupee and, in particular, rising energy costs.

Exports of readymade garments have increased by over 23 percent, with a 10 percent jump in the dollar price and 13 percent enhancement in the quantity exported. This has been facilitated by the disturbed conditions in Bangladesh. Similarly, knitwear exports have increased by almost 19 percent.

There have also been some positive developments on the import side. Large imports of POL products and crude oil have taken place during July to December 2024, with a big reduction in the dollar prices by over 13 percent. Also, the SBP has continued to exercise some controls on imports.

To top it all, there is the phenomenal growth in workers’ remittances of almost 33 percent. The official inflows have increased due to the closing of the gap between the hundi and the official exchange rates.

Therefore, we see today a degree of complacency on the economic situation. Foreign exchange reserves provide import cover for over two months and are close to the level projected by the IMF for December 2024. The stability in the value of the rupee has implied less imported inflation and contributed significantly to keep the rate of inflation at the very low 4 percent.

But there is need now for a note of caution. First, oil prices are rising sharply and have gone up recently by almost 14 percent, to above USD 80 per barrel. Second, following the assumption of office by Donald Trump there is likely to be a hike in import tariffs in the USA. This will affect Pakistan’s exports to its largest market.

Third, there will be need for substantially higher cotton imports due to the poor crop. The size of the forthcoming wheat crop may also imply larger wheat imports.

There is need also to recognize that the positive trends in the current account have shrouded the negative developments in the financial account of the balance of payments.

The financial account has shown only a marginal surplus of $544 million in the first six months of 2024-25. This is in comparison to a relatively large surplus of $4,929 million in the corresponding period of 2023-24. The primary reason for this is the fall in the inflow of net external assistance to the government. It was $2,125 million in the first six months of 2023-24 and actually a negative $353 million between July and December 2024. Overall, the surplus in the balance of payments was USD 3,006 million in July to December 2023 as compared to USD 1,711 million in the last six months.

The first comprehensive review of the IMF is due in late February. There are a number of quantitative performance criteria, indicative targets and structural benchmarks which may not been met as of December 2024. The review must be successfully completed, otherwise there will be a peaking of risk and uncertainty. This will lead to a situation where the new-found stability of rupee in 2024 will be difficult to sustain. Overall, this will be the true test of economic management by the SBP in the coming months.

Copyright Business Recorder, 2025