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Multiple impacts of a falling rupee

By Mohiuddin Aazim

 The falling value of the rupee will have many fiscal and monetary implications, including an increase in the rupee-cost of external debt servicing and a rise in liquidity levels.

And depreciation of the rupee is partially explained by the recent central bank’s buying of $125 million from the interbank market.

It is not unusual for the State Bank of Pakistan (SBP) to buy dollars from banks, either on spot or through swaps. “But this time, the buying is covered under the scope of the IMF’s new lending programme,” says the treasurer of a large local bank. ‘That’s unusual.”

How much more the SBP may have to buy from banks is not difficult to guess, as under the current IMF programme of $6.7 billion, the central bank is supposed to raise its forex reserves (excluding those held by commercial banks) to over $9.5 billion by June 2014, from about $5.5 billion in September 2013.

“Buying from banks is not the only thing we’ll be doing,” says a central banker, pointing towards the government’s recent deal to borrow $625 million from a consortium of banks, in addition to scheduled inflows through the IMF financing line and development lending plans of foreign governments and international financial institutions.

The $625 million borrowings will directly boost forex reserves, as “these banks shall mobilise foreign exchange either through their overseas branches or principal offices or via other means, instead of dishing it out from their locally held foreign currency deposits,” the head of one of these banks told Dawn. He said the banks would readily do it, as the interest rate of 5.3 per cent on the dollar-denominated lending is quite lucrative.

A 100-paisa fall in the rupee’s value against the dollar adds Rs1 billion to the external debt servicing of $1 billion. Besides, it adds Rs60 billion, though mostly for accounting purposes, to the country’s overall external debt and liabilities of around $60 billion.

The rupee has lost 6.2 per cent value, as it fell to Rs105.86 a dollar on September 21 from Rs99.666 at the end of June.

If we assume that the rupee regains some of its lost value in the remaining days of this month, and its first quarter loss is contained at around 600-paisa per dollar against the so far loss of 620-paisa, the cost of the end-quarter external debt servicing would be higher by Rs6 billion on $1 billion. And the additional book cost of the stock of external debt and liabilities would be Rs360 billion.

Officials of the ministry of finance say it’s difficult to calculate the exact impact of the rupee decline on the external debt and debt servicing requirement before time.

“All of the external debt servicing doesn’t take place by the end of each quarter. Payments are made as and when they become due. And at that time, the actual rupee depreciation could be different than its quarterly or yearly depreciation,” argues one of the officials.

“Besides, quite often the government arranges foreign exchange ahead of the due date of payments. And sometimes, the SBP makes rupee-dollar swaps with banks, keeping in view the market requirement of foreign exchange ahead of external debt payments.”

But generally speaking, the decline in the rupee’s value during one quarter or a full fiscal year can be taken as the percentage of additional rupee expenses in external debt payments — at least on book value — during that period. And that naturally requires additional budgetary allocations under this head, squeezing the space for development spending. Besides, the buildup in the rupee cost of the overall external debt disturbs the debt sustainability ratios in terms of the local currency.

From the central bank’s point of view, the fall of the rupee and the consequent creation of the additional rupee-counterpart of external debt servicing are bad because they increase liquidity in the interbank market, thus putting more pressure on the exchange rate.

Interestingly, however, a buildup in liquidity in the interbank market helps the government to borrow from banks at cheaper rates and contain its domestic cost of borrowing. That also offsets, to some extent, the increase in the cost of external debt servicing.

The situation brings at least one good to the SBP, as it reduces the need for pumping of additional liquidity into the interbank market ahead of auctions of treasury bills and bonds to facilitate the government’s borrowing requirement.

But the SBP may have to continue its old practice of keeping the market liquid enough ahead of the government’s borrowing from commercial banks for some time. “After the recent hike of 50 basis points in the SBP’s policy rate, T-bill and PIB rates are moving up,” says a source close to the central bank.

“Already a very big rise in the government’s bank borrowing in the last few years has increased its cost of domestic debt servicing. If the SBP doesn’t help the government keep the cost at reasonable levels, the resultant increase in it would frustrate its plans to contain the fiscal deficit.”

In July-August FY14, the fiscal deficit was around one per cent of GDP because of revenue surpluses of the provinces. But to keep the full fiscal year deficit at the targeted 5.8 per cent, containing the cost of domestic debt servicing is critical.

As the rupee has lost more than six per cent against the dollar so far this fiscal year, it may keep the growth in imports somewhat under check, thereby lowering the trade deficit and having a positive impact on the external current account.

But any decline or sluggish growth in imports will eventually lower the collection of duties and taxes at the import stage, and impact on fiscal management.

And while a weaker rupee does support exports — again helping on the external front — higher exports hardly have a positive impact on revenue collection. Instead, if exports of food items grow faster, it would start producing demand-pull inflation.

This, along with the general impact of the rupee depreciation on imports via an increase in prices of such critical imports as fuel oil and industrial raw materials, is not in any way going to help economic growth, industrial output expansion, or private sector investment.

In a recent newspaper article, Dr Ashfaque Hasan Khan said, “the [IMF] programme has failed to bring the rich and the powerful into the tax net. The IMF did not have the courage to mention bringing agricultural income under the direct tax net”.

Courtesy: Daily Dawn

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