'Highest PKR overvaluation ever': rebuttal

Ms Anjum Ibrahim has written an article titled "Highest PKR overvaluation ever" carried by Business Recorder dated 16-01-2017. The article claims that Pakistan maintains a 'dirty float' due to frequent interventions in the FX market. Further, the frequency of such interventions is more pronounced in recent times. The author has also claimed that the rise in foreign exchange reserves from $13.6 billion in February 2013 to $20.6 billion in March 2016 are overstated as it includes private sector foreign exchange held in commercial banks.
In this regard, it would be worth noting that central banks usually intervene in the FX markets mainly to curb excessive volatility and ensure smooth functioning of the markets. This can help keep exchange rate stable, which is also considered one of the essential ingredients of sustainability of a country's external sector.
The notion that strong currency hurts an economy is also debatable, as there are pros and cons of it. In case of Pakistan, the exchange rate stability not only helped improved external outlook of the country but also augmented the efforts aimed at maintaining price stability in the country. Pakistan's rating has also been improved by Moody's and the S&P.
The article computes the differential between the REER index and average exchange rate, which reveals that the differential has increased from 3.4565 in March 2013 to 21.29 in November 2016. The author also argues that this differential will further widen unless:
-- The government does not end its reliance on domestic and short-term external expensive borrowings;
--Reduces the magnitude of local borrowings;
-- Reverses the decline in exports (allowing PKR to reflect market conditions);
-- FDI is not increased; and
-- The revenue is raised through stock markets instead of relying on taxes.
This kind of analysis by the writer is erroneous which leads to misleading interpretations of the CPI-based REER index. Particularly, making a comparison of REER index with the average nominal exchange (PKR vs. US dollar) is inappropriate, as REER index is a measure of trade-weighted average exchange rate of a currency against a basket of currencies after adjusting for inflation of the countries concerned and expressed as an index number relative to a base year. In this context, a percentage change of REER index at two point of time is computed to assess external value of a currency against the trading basket. Further, the REER index is a crude measure of external competitiveness of a country, as economic theory still lacks a foolproof method of establishing an over or undervaluation of a currency.
Also, the deviations in REER index don't necessarily indicate fundamental misalignment as some important factors also matter for competitiveness, such as consumption pattern, trade policies, tariffs and transportation costs, etc. This is the reason that some other improved methodologies based on macroeconomic balance approach/partial equilibrium/general equilibrium models are also employed by central banks (including Pakistan) while assessing external competitiveness of an economy.
Further, some other established measures are also used in assessing the competitiveness of an economy. For example, the Global Competitiveness Report 2015-16 has ranked Pakistan 122nd out of 138 countries, up from 126 last year. This improved ranking was achieved mainly on the back of the country's higher scores for 'getting credit' and 'registering property' categories, as compared to the previous year. Further, the World Bank's Doing Business Report 2017, also improved Pakistan's overall ranking to 144 (out of 190 countries), from 148 last year.
In the article, the author agrees with the recent build-up of Pakistan's FX reserves. However, it raises a question regarding its composition, as she claims that this accumulation of reserves was entirely replenished through external debt generation. This kind of perception regarding FX build-up is also wrong, as a variety of factors were responsible for the FX reserves accumulation. For example, the major source of build-up of SBP's FX reserves include: (i) multilateral and bilateral loans and grants from development partners; (ii) issuance of bonds in the international capital market; (iii) inflows under the Coalition Support Fund; and (iv) SBP's spot purchases from the interbank market.
Further, the FX reserves, which stood at US$6.0 billion by end-June 2013 were not sufficient to finance even two months of the country's import bill: the PKR depreciated by 8.2 percent during July-November 2013. However, these reserves have recorded an average growth of 44.5 percent between FY2013 and FY2016 to reach US$18.1 billion by end-June 2016. These reserves are sufficient to finance around five months of the country's import bill.
As regards the issue of inflows of overseas workers' remittances to Pakistan, these are still healthy if compared with other South Asian countries. During FY2016, the slowdown in workers' remittances was owing to exogenous factors, such as the low global oil prices affecting revenues of the Gulf region (which contributes around 65 percent to Pakistan's remittance inflows), stringent regulations faced by money transfer operators from USA, and subdued growth in the developed world, another source of remittance inflows for Pakistan. Despite these challenges, remittance inflows in Pakistan passed their target in FY2016 and reached almost US$20 billion. It is also pertinent to mention that development activities under Saudi Arabia's vision 2030, FIFA World Cup 2022 in Qatar, and Expo 2020 in Dubai may create demand for Pakistani workers, which can help increase flow of remittances in the country.
On the investment front, FDI has been more than doubled from US$0.9 billion in FY2015 to US$1.9 billion in FY2016. During Jul-Dec, FY17 FDI posted a significant growth of 10.4 percent and YOY in December it registered a growth of 328 percent. While Foreign Portfolio investment (FPI) has posted a phenomenal growth of above 200 percent during the same period of current fiscal year. In addition, with the establishment of special economic zones (SEZs) planned under the China-Pakistan Economic Corridor (CPEC), foreign investments are expected to improve further. Pakistan's private sector involvement is also likely to enhance in building the infrastructure of power plants and road network. This would also boost Pakistan's productive capacity and expand the country's export base. As a result, Pakistan may generate incremental foreign exchange to service debt and equity investment.
As regards decline in the country's exports, it is primarily due to weak demand in major export markets. Not only Pakistan, but most emerging markets (EMs) have witnessed a drop in their exports. However, in a bid to save the external trade, the government has introduced a bailout package of Rs 180 billion for export sector to positively impact textile sector. The package includes enhanced Drawback of Local Taxes and Levies (DLTL) rates with inclusion of yarn/grey fabric to the DLTL list, removal of customs duty and sales tax on import of cotton. Similarly, the government has abolished customs duty on man-made fibre and sales tax on import of textile machinery. Particularly, the technological revival of the textile sector can help exports to compete with other regional competitors such as Bangladesh, Philippines and Vietnam.
The article also incorrectly stated that domestic debt witnessed an increase of 66 percent during last three years. Further, it used incorrect facts and figures to arrive at misleading conclusions with regards to external public debt. In this regard, it is to mention that the present government inherited net public debt of Rs 14,291 billion comprising of external public debt of $48.1 billion (Rs 4,797 billion) and net domestic public debt of Rs 9,494 billion. During the period from July 2013 to June 2016, the net public debt has grown to Rs 19,219 billion out of which the external public debt was $57.7 billion (Rs 6,051 billion) while net domestic public debt was Rs 13,168 billion. Thus, there is a net increase of Rs 4,928 billion in total public debt, inclusive of $9.6 billion of external debt. This constitutes an increase in net public debt at an annual compounded growth rate of 10.4 percent during first three years of the present government as compared with compounded annual growth of 19.9 percent recorded during the tenure of previous government.
A better approach is to measure the net external indebtedness of the country, which is the difference between external public debt and official FX reserves. Net external indebtedness of the country improved by US$4.50 billion by end June 2016 as compared with end June 2013.
The debt burden is better understood in comparison to its relation with the GDP instead of absolute numbers. The analysis of public debt to GDP ratio during last 15 years reveals that in the period of high inflation, public debt to GDP ratio performed relatively better as the denominator becomes larger and this ratio mostly hovered close to 60 percent even when real GDP growth was merely half a percent. For instance during the tenure of previous government (2009-2013), the average inflation remained around 12 percent while real GDP was only 2.8 percent. Whereas, during the tenure of present government, the average inflation remained around 5 percent while real GDP was over 4 percent. The higher inflation could help reducing the public debt-to-GDP ratio yet it has other adverse repercussions for the economy. Therefore, economic managers would always prefer high real GDP growth coupled with low inflation rather than low real GDP growth coupled with high inflation. Another way to gauge the increase in public debt burden of the country is to compare with relevant global public debt statistics. Pakistan's net public debt to GDP ratio increased marginally by 1.1 percent during last three years as compared with 6.8 percent increase witnessed in global debt to GDP ratio (IMF World Economic Outlook, October 2016).
The article incorrectly stated that the government is accused of heavy unsustainable reliance on external and domestic borrowing. In fact, the government has been able to reduce the risks associated with its public debt portfolio through re-profiling of its domestic debt portfolio, broadening of investor base through commencement of trading of government debt securities at stock exchanges and mobilisation of concessional external debt to retire its expensive domestic debt. Major debt sustainability indicators have in fact improved in the last three years, a fact that is acknowledged by global stakeholders.
-- "Refinancing Risk of the Domestic Debt Portfolio" was reduced through lengthening of the maturity profile at the end of June 2016. Percentage of domestic debt maturing in one year was reduced to 51.9 percent compared with 64.2 percent at the end of June 2013;
-- "Exposure to Interest Rate Risk" was also reduced, as the percentage of debt re-fixing in one year decreased to 44.4 percent at the end of June 2016 compared to 52.4 percent at the end of June 2013;
-- "Share of External Loans Maturing within One Year" is equal to around 31.9 percent of official liquid reserves at the end of June 2016 as compared with around 68.5 percent at the end of June 2013 indicating improvement in foreign exchange stability and repayment capacity;
-- The IMF debt sustainability analysis shows that external debt would remain on a downward trend over the medium term, with the peak in external financing needs under the most stressed scenario (3.7 percent of GDP) staying well below the risk assessment benchmark of 5 percent of GDP. Further, credit rating agencies in their recent reports acknowledged this fact that Pakistan external debt is on sustainable path and there is very little exposure to medium term vulnerabilities.
Lastly, the news article made a false assertion regarding component of external public debt especially with reference to rising external commercial borrowing and Eurobonds. In this regard, following may be noted:
-- The average cost of the external loans obtained by present government comes to around 3 percent which is significantly lower than the domestic financing cost even after one builds a margin of capital loss due to exchange rate depreciation;
-- Eurobonds and commercial loans outstanding amounts were only US$4.6 billion and US$1.5 billion respectively, having combined share of only 10 percent within external public debt as at end June 2016. Remaining 90 percent of external public debt is contributed by concessional multilateral and bilateral sources, which are instrumental in enhancing Pakistan's potential output by promoting efficiency and productivity. These loans are, thus, simultaneously adding to the debt repayment capacity of the country.