Free fall of rupee: corrective measures are not enough

What is important is, whether the measures taken recently are enough to keep rupee-
dollar parity stable and the answer is definitely in negative. These measures may be able
to curtail some demand of the dollar back from the market but still the pressure
emanating from the imports is immense and hard to be neutralised by these measures

By Zafar-ul-Hassan Almas

The rupee has lost 7.2 per cent of its value in less than few-days and this is the fastest pace of depreciation in almost one decade. The SBP has responded although reluctantly by easing curbs on financing for imports such as provision of foreign exchange for oil imports, suspension of forward booking of dollars, reduction in trading time, curtailment of advance payment against imports from 50 to 25 per cent etc. The SBP has made it obligatory for foreign exchange companies (both A and B category) to seek prior approval from SBP for all transactions of US$ 50,000 and above – on account of outward remittances or sale of foreign currency. Now SBP has shown its willingness to intervene in the market by transacting at around Rs.71 to a dollar. These measures were able to provide stability to the exchange rate for the last two days. To ensure exchange rate stability is the primary responsibility of all central banks including the State Bank.

The million-dollar question is whether these measures are enough to keep rupee-dollar parity stable and the answer is definitely in negative. These measures may be able to shave-off some demand of the dollar back from the market but still the pressure emanating from the imports is immense and hard to be neutralized by these measures. Notwithstanding, these corrective measures were absolutely required to arrest the fast depreciation of the rupee and these measures has helped the rupee to regain some of its lost value against the dollar. Our past experience with such measures is not very good.

The current free fall of the rupee is yet another evidence of fragility of our economic fundamentals, unbridled surge in inflation, lingering political instability, structural rigidities and weaker governance in the country. The uncertainty surrounding the economy is the major root-cause of the problem and unless the government is taking these real issues seriously, the rupee would keep on depreciating. The structure of governance is not supportive to the regulatory environment. It seems that the government is not taking the economy seriously and it is evident from the fact that everybody who matters in the government is out of the country on joyride trips at the cost of national exchequer. The precious foreign exchange is wasted like tissue papers by the government functionaries. Pakistan should learn from the experience of the East Asia in the aftermath of the financial crisis of 1997, especially Malaysia took stern measures to stop travels abroad to save precious foreign exchange. The austerity measures and saving foreign exchange had helped Malaysia to recover from the crisis shortly.

The corrective measures by the State Bank could not withstand the demand pressure too long and may follow further monetary tightening. The trade imbalance in June alone was more than $ 2 billion. The rising prices of crude oil in the international market coupled with spike in prices of imports of food items have exerted immense pressure on demand. During the outgoing fiscal year the imports has almost touched $ 40 billion mark while exports stood at $19 billion. The outgoing year witnessed an addition of $2 billion to exports and $10 billion to imports. The mismatch between growth in exports and imports is rising at a faster pace. Although around 40 percent contribution to additional import bill is coming from rising prices of crude oil and another 25 percent is because of inordinate rise in imports of wheat, edible oil and fertilizer, but still we should review our structure of imports. We can easily slash some of non-essential imports through fiscal measures, administrative measures like rationing of petroleum, and import substitution.

The current account deficit has touched all time high at over $13 billion and financing is inadequate. Pakistan badly needs external inflows to stabilize the exchange rate. The outgoing fiscal year (2007-08) has left a legacy of dwindling inflows and FDI inflows registered negative growth for the first time in the last 6 years, portfolio investment actually recorded outflow, and expected equity inflows withered away in uncertainty. Ministry of Finance was arranging foreign exchange through exchangeable bonds and sale of stake in public sector enterprises but the fate of such moves is not known to any body. The response from friendly countries in provision of much needed inflows was not encouraging. The current crisis of free fall of rupee is basically an ultimate result of half-hearted moves of arranging foreign exchange. It seemed that economic policy makers are not reacting or not comprehending the implications of inflows.

The government should gear-up its privatisation efforts and launch the proposed Global Depository Receipts (GDRs) to bring much needed foreign exchange in the country. The government should explore all possible avenues of foreign exchange by indulging into loan agreements or arrangement of non-debt creating inflows. This would bridge the demand and supply gap between demand for dollar and supply of dollar. The SBP has already lost around $ 5 billion worth of its precious foreign exchange reserves which fell from its peak level of $16.4 in November 2007 to $11.1 billion by end-June 2008. The import cover has declined to below 3 months of financing for the first time in the last five years and it has definitely some bearing on the psychology of the ordinary investor and sending wrong signals to the speculators in the foreign exchange market.

The speculators are hoarding dollars to reap maximum benefit of the situation. It is very difficult even for the SBP to convince the speculators to sell their dollars in the market but if SBP is able to stabilize the rupee for longer periods, the dollar supply would be normalized. The current crisis was aggravated by some unscrupulous importers as well. The huge quantum of imports of fertilizer during the month of April 2008 at the level of 110 million against normal imports of less than 0.2 million tons a month is still a mystery. The government should take punitive action against the culprits to show its commitment to curtail non-essential imports. This type of imports is putting un-necessary pressure both on our import bill and the exchange rate.

Notwithstanding the SBP’s frequent interventions to stabilize the exchange rate, the rupee has lost 18.9 per cent of its value against US dollar since January 2008. This reinforces the need to tackle basic economic and political issues immediately otherwise the combined impact of political and economic mismanagement could be proved disastrous. The current crisis of free fall of rupee is equally contributed by a credibility deficit emanating from general perception about country’s economic conditions and fear element among investors about future prospects of political stability.

The rupee needs support from various areas like conservation of energy to ease pressure on import bill of petroleum products and rationalize non-essential imports. The SBP alone could not counter the menace of depreciation without ample support from political stability, enabling environment, allaying fear element from investor confidence, improved general public perception about sustainability of economic fundamentals, and improved credibility about the government policies.  The current account deficit might be a great problem but credibility deficit is more dangerous than it. The current account deficit is not Pakistan specific and almost every developing country is facing the problem but we have to review our specific problems like political stability and element of mistrust about the government policies.
Source: the News, 14/7/2008

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