Through a joint statement issued by Ministry of Finance and State
Bank of Pakistan, all the stakeholders and public in general has been assured
that the present trauma will ease. While one may not agree with some of the
points, this is an official strategy and only wait and see stance could be
adopted.
Pakistan’s
problems are temporary and are being forcefully addressed
Pakistan’s foreign exchange reserves have fallen since
February as foreign exchange inflows have been outpaced by outflows. The
inflows mainly comprise of multilateral loans from the IMF, World Bank and ADB;
bilateral assistance in the form of deposits and loans from friendly countries
like China, Saudi Arabia, and the UAE; and commercial borrowing from foreign
banks and through the issuance of Eurobonds and Sukuks. The paucity of inflows
has happened in large part due to the delay in completing the next review of
the IMF program, which has lingered since February due to policy slippages.
Meanwhile, on the outflows side, debt servicing on foreign borrowing has continued
as repayments on these debts have been coming due over this period.
At the same time, the exchange rate has come under
significant pressure, especially since mid-June. It has been driven by general
US dollar tightening, a rise in the current account deficit (exacerbated by a
heavy energy import bill in June), the decline in foreign exchange reserves,
and worsening sentiment due to uncertainty about the IMF program and domestic
politics.
However, important developments have happened recently that
will address both of these temporary issues. On July 13, the critical milestone
of a staff-level agreement on completing the next IMF review was reached. As of
today, all prior actions for completing the review have been met and the formal
Board meeting to disburse the next tranche of US$1.2 billion is expected in a
couple of weeks. At the same time, macroeconomic policies—both fiscal policy
and monetary policy—have been appropriately tightened to reduce demand-led
pressures and rein in the current account deficit. Finally, the government has
clearly announced that it intends to serve out the rest of its term until
October 2023 and is ready to implement all the conditions agreed with the Fund
over the remaining 12 months of the IMF program.
In
FY23, Pakistan’s gross financing needs will be more than fully met under the ongoing
IMF program
The financing needs stem from a current account deficit of
around US$10 billion and principal repayments on external debt of around US$24
billion.
In order to bolster Pakistan’s foreign exchange reserves
position, it is important for Pakistan to be slightly over-financed relative to
these needs.
As a result, an extra cushion of US$4 billion is planned
over the next 12 months. This funding commitment is being arranged through a
number of different channels, including from friendly countries that helped
Pakistan in a similar way at the beginning of the IMF program in June 2019.
Important
measures have been taken to contain the current account deficit
In addition to high global commodity prices, the large
current account deficit in FY22 was driven by rapid domestic demand (growth
reached almost 6 percent for two consecutive years leading to overheating of
the economy), artificially low domestic energy prices due to the February
subsidy package, an unbudgeted and procyclical fiscal expansion, and heavy
energy imports in June to minimize load-shedding and build inventories.
To contain this deficit going forward, the policy rate was
raised by 800 basis points, the energy subsidy package has been reversed, and
the FY23 budget targets a consolidation of nearly 2.5 percent of GDP, centered
on tax increases while protecting the most vulnerable. This will help cool
domestic demand, including for fuel and electricity.
In addition, temporary administrative measures have been
taken to contain the import bill, including requiring prior approval before
importing automobiles, mobile phones and machinery. These measures will be
eased as the current account deficit shrinks in the coming months.
These
measures are working, the import bill fell significantly in July, as energy
imports have declined and non-energy imports continue to moderate
Foreign exchange payments in July were significantly lower
than in June. This is true for both oil and non-oil payments. Altogether,
payments were a sustainable US$6.1 billion in July compared to US$7.9 billion
in June.
The latest trade data indicate that non-oil imports continue
to fall. Specifically, non-oil imports fell by 5.7%QoQ during Q4 FY22. They are
expected to reduce further going forward.
Looking ahead, a considerable slowdown has been witnessed in
LC opening in recent weeks, again for both oil as well as non-oil commodities. Based
on market reports, there was an 11%MoM decline in Oil Marketing Companies sales
volume in June.
After the surge in energy imports in June, a stock of diesel
and furnace oil sufficient for 5 and 8 weeks, respectively, is now available in
the country, much higher than the normal range of 2 to 4 weeks in the past.
This implies a lower need for petroleum imports going forward.
With the recent rains and storage of water in the dams,
hydroelectricity is also likely to increase and need to generate electricity on
imported fuel is expected to decline going forward.
As a result of these trends, the import bill is likely to
shrink going forward and should begin to manifest itself more forcefully in lower
FX payments over the next 1-2 months.
Overall, imports are expected to decline in coming months
due to a decline in global commodity prices, the higher oil stock, the
unfolding impact of higher domestic prices of petroleum products, adjustments
in electricity and gas tariffs, the removal of tax exemptions under the FY23
budget, administrative measures taken to curtail imports, and the lagged impact
of the monetary and fiscal tightening that has been undertaken.
The
Rupee has overshot temporarily but it is expected to appreciate in line with fundamentals
over the next few months
Around half of the Rupee depreciation since December 2021
can be attributed to the global surge in the US dollar, following historic
tightening by the Federal Reserve and heightened risk aversion.
Of the remaining half, some is driven by domestic
fundamentals, in particular, the widening of the current account deficit,
especially in the last few months. As noted above, the deficit is expected to
narrow going forward as the temporary surge in the import bill is brought under
control. As this happens, the Rupee is expected to gradually strengthen.
The remaining depreciation has been overdone and driven by
sentiment. The Rupee has overshot due to concerns about domestic politics and
the IMF program. This uncertainty is being resolved, such that the
sentiment-driven part of the Rupee depreciation will also unwind over the
coming period.
Where the market has become disorderly, the State Bank has
continued to step in through sales of US dollars to calm the markets and will
continue to do so, as needed in the future. Strong steps to counter any
speculation have also been taken, including close monitoring and inspections of
banks and exchange companies. Further additional measures will be taken as
situation warrants.
Rumors that a particular level of the exchange rate has been
agreed with the IMF are completely unfounded. The exchange rate is flexible and
market-determined, and will remain so, but any disorderly movements are being
countered.
Going forward, as the current account deficit is curtailed
and sentiment improves, we fully expect the Rupee to appreciate. Indeed, this
was the experience during the beginning of the IMF program in 2019, when the
Rupee strengthened considerably after a period of weakness in the lead-up to
the program.
Clearly, the Rupee can overshoot temporarily as it has done
recently. However, it moves both ways over time. We expect this pattern to
re-assert itself in the coming period. As a result, the Rupee should strengthen
in line with improved fundamentals in the form of a smaller current account
deficit as well as stronger sentiment.
