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Declining forex reserves

Pakistan’s total liquid foreign exchange reserves stood at $8.8 billion on November 22, 2013 of which the State Bank of Pakistan and commercial banks accounted for $3.46 billion and $5.33 billion, respectively. Commercial banks’ foreign exchange reserves are essentially the deposits of both residents and non-residents under the FE Circular No 25. These reserves are, therefore, not usable by the government for balance of payments purpose. However, trends in the commercial bank reserves did convey some messages for the state of the economy.

The SBP’s foreign exchange reserves declined to a dangerously low level of $3.46 billion on November 22, 2013. Pakistan also made a payment of $396 million on November 26, 2013 to the IMF. If this payment is accounted for, it would mean that the SBP’s foreign exchange reserves stood at a mere $3 billion by end-November 2013. This is the lowest level of reserves of the country in the last twelve years and is sufficient only to finance three weeks of import.

Pakistan’s foreign exchange reserves have been on the decline since July 2011 when they stood at $14.8 billion. Pakistan has lost $12.0 billion reserves in just 29 months – by end-November 2013. It has lost $2.2 billion reserves in just four months (since July 2013) and $1.7 billion since signing the IMF programme. The country is scheduled to pay another $200 million to the IMF in December, 2013 and $1.24 billion during January-June 2014. Unless massive inflows are injected fairly soon, we may witness a currency crisis in December 2013.

Why has the country landed in such a vulnerable situation? Stagnant exports, declining foreign inflows owing to the suspension of the previous IMF programme in May 2010, rapidly declining foreign investment, little or no privatisation proceeds, failure on the part of the government to raise dollars from international debt capital market and declining grant assistance are the principle reasons for the rapidly declining foreign exchange reserves.

Moreover, rising debt repayments and growing imports in conjunction with the fact that Pakistan is continuing to finance all its external payments out of its own reserves have also contributed to the sharp decline in reserves. Rapidly depleting reserves create nervousness in the market and encourage capital flight, which, in turn, puts downward pressure on the exchange rate. The Pakistani rupee, accordingly, has lost almost 18 percent of its value against the dollar since July 2011.

Given the state of the economy that evolved over the last five years, Pakistan reached the brink of defaulting on its external debt repayment obligations by June 2013. The new government had little or no choice but to seek yet another IMF programme to prevent the country from defaulting on its external debt payments. The IMF approved a new programme amounting $6.68 billion on September 4, 2013.

It was expected that the new programme would bolster market confidence, help build foreign exchange reserves, prevent the country from defaulting on its external payment obligations, and open the door for external inflows from other sources.

Nothing has been achieved thus far from the programme. It has failed to bolster market confidence and foreign exchange reserves have declined to a twelve-year low; the country has reached dangerously close to default, and has failed to bring inflows from other sources as well. Pakistan remains as vulnerable as it was prior to the programme.

It is in this perspective that this columnist and other commentators have been highlighting the weaknesses of the current IMF programme. One of the key weaknesses is the size of the release of tranche itself. Pakistan has received $547 million as the first tranche of the programme in September but repaid about $975 million to the IMF during the period, implying a net outflow of $428 million.

It appears the IMF was more interested in securing its own outstanding loan by releasing little resources and encouraging other multilateral development institutions to lend to Pakistan so as to enable it to continue to repay the IMF loan. The IMF deliberately understated the current account deficit to show a lower financing gap to build a case for smaller tranches.

The IMF programme is also designed in such a way that it forces the SBP to purchase dollars from the market and borrow from whatever sources it can, with a view to building its foreign exchange reserves and continuing to repay the IMF loan on time. In the words of Dr Muhammad Yaqub, former governor of SBP, this is nothing but a “self-serving programme”.

Pakistan’s foreign exchange reserves were already on the decline and it continues to follow the same trajectory even with an IMF programme. Isn’t that strange? Is this the way the IMF provides financial support to its member states? Such a self-serving programme will cause more harm to the economy and the people rather than benefitting the country.

While the country’s foreign exchange reserves are declining rapidly and reaching a dangerously low level, commercial bank reserves have been rising steadily in recent years and reflecting the growing dollarisation of the economy. Commercial bank reserves were only 17.2 percent of the SBP’s reserves in 2006-07. They increased to 41.5 percent in 2011-12, accelerated to 83.4 percent in June 2013 and reached 154 percent on November 22, 2013. While Pakistan has lost almost $12 billion from its reserves since July 2011, commercial banks on the other hand have gained almost $2 billion in their reserves.

The pace of dollarisation has gathered momentum in recent months as people are losing confidence in their own currency. The expectations of further depreciation of the rupee are encouraging people to hold more dollars. The government needs to restore the confidence of the people on its own currency by minimising its recourse to printing money. This is not happening at the moment. The government has borrowed Rs751 billion in 131 days of the current fiscal year or Rs5.73 billion per day or Rs239 million per hour. Such a pace of borrowing is bound to weaken the confidence of the people in the rupee.

The government should take the matter seriously. There are people sitting in the SBP who misguided the previous regime and are doing the same with the present one by arguing that there is ‘no foreign exchange crisis in the country’. Such statements are not in the interest of the country. The fact is that our foreign exchange reserves have declined to $3 billion by the end of November 2013. No one can deny this fact. This is a dangerous situation and needs the government’s urgent attention.

I would urge the prime minister to take the economy seriously, strengthen the government’s economic team, ask them to take another look at the IMF programme and listen to the people with known credentials. Are we waiting to taste the flavour of being a bankrupt nation? Some country or institution may come forward to bail us out but at what cost?

The writer is the principal and dean of NUST Business School. Email: ahkhan@nbs.edu.pk

Dr. Ashfaque H Khan, "Declining forex reserves," The News. 2013-12-03.
Keywords: Economics , Economic issues , State Bank-Pakistan , Government-Pakistan , Foreign exchange , Economic development , Economic needs , Foreign investment , Economy-Pakistan , Imports-Pakistan , Dr. Muhammad Yaqub , Pakistan , IMF , SBP