The pattern is now predictable; the caretakers are taking lead from where it was left by Miftah and Abassi duo. The first round of currency depreciation took place in second week of December, followed by another round in March and now in June.
In an analysis published on Mar 21 2018 titled “The second round of depreciation“ the move was predicted - “The need is to keep the currency at current level (Rs 115-116 per USD) till June and if needed, take it down to Rs 120 per USD and then sit tight to reap depreciation fruits. Any further slide in currency from Rs 120/USD would be counterproductive”.
Now 120 level is here. What next? There are high chances to let the currency to stay at this level for time being to see the impact. But in Islamabad, the atmosphere is pessimistic - expect the unexpected to happen.
It is hard to tell when this rupee slide will stop; as it is a judgment call that the equilibrium is reached. The real effective exchange rate (REER) reached at 111 in April 18 from 124 in Nov17. The reason for fast adjustment towards equilibrium was that not only PKR slide against USD by 9.5 percent; but USD was also weakening against other currencies.
The PKR depreciation against trading partners was higher than its downward movement against USD. Hence, the higher REER adjustment. Therefore, the REER was expected to come down further in May and June. However, recently USD has started appreciating against other currencies and the REER could have moved up in May.
According to Topline Research calculations the REER, prior to yesterday’s depreciation, was at 113-114. Thus, after depreciation, it may come down to 109-110. This implies another round of 3-5 percent depreciation cannot be ruled out in weeks or months to come.
The question is how much the depreciation alone can bring macroeconomic stability. The short answer is nothing much. The core of the economic problem in Pakistan is fiscal slippages and without mending the fiscal woes, no currency adjustment can bring external account to balance.
What actions caretakers are taking on lowering fiscal deficits? What other demand management steps are being taken to lower the imports? Not many. The shocking step is that despite upward revision in international oil prices, the petroleum prices at home have been kept unchanged in June. There are rumors that caretaker will not alter the prices in July and would leave it to new government to take corrective actions.
The basis for no change is that it’s not in the mandate of caretakers to fix petroleum prices. How naive this logic is; as the prices are revised every month based on change in international prices, and at this junction the most effective demand management tool is to tax petroleum consumption.
The low tax will have its toll on fiscal deficit which is already too high. Then there is dire need to upward adjust energy prices - both electricity and gas tariffs are required to move up to lower the quasi fiscal debt.
Apart from that, interest rates ought to move up as the core inflation has already reached 7 percent and the currency depreciation would have its impact on inflation. Since domestic food prices are already at premium to international prices, the currency depreciation is yet to impact food prices and the gap may also absorb the third round of depreciation.
However, this cannot go for long. Any further depreciation would have its toll on inflation. And more importantly, isolated currency depreciation without petroleum and energy prices upward revisions, and tightening of monetary policy could be counterproductive.
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