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Dwindling forex reserves and bravado

Consumer Price Index rose to 36.4 percent in April – a rise of one percent from March 2023, 23.7 percent from March 2022 and if one takes away the economically unviable relief package announced by the then Prime Minister Imran Khan on 28 February (effective 1 March) then 24.2 percent higher than the rate effective in February 2022.

One factor for the rise in the rate of inflation is undoubtedly external to domestic policy making: Russian attack on Ukraine launched on 24 February 2022 prompting a US-led ban on oil imports from Russia which raised the international price of oil and products as well as grain (Ukraine was the fifth largest grain exporter in the world before the war). Oil and grain are two of Pakistan’s critical import items, and therefore as their price rose internationally our foreign exchange reserves dwindled to less than the minimum three month of imports suggested by donor agencies and economists. But can the blame be laid entirely on external factors?

Pakistan’s foreign exchange reserves defined as those held by the State Bank of Pakistan (SBP), have been dwindling since the Khan administration left office on 9 April 2022. On 8 April 2022, the day before the fall of the Khan administration, reserves were 10.849 billion dollars, declined to 10.03 billion dollars by 24 June 2022, to 7.859 billion dollars on 30 September 2022 to 5.585 billion dollars on 30 December 2022 and 3.08 billion dollars on 27 January 2023.

Two observations are in order. First to reiterate with the rise in the international price of oil and grains Pakistan’s reserves, like many other countries experiencing similar balance of payment pressures, plunged from 10.03 billion dollars on 8 April 2022 to 7.859 billion dollars by end September 2022. Given that the staff level agreement with the International Monetary Fund (IMF) was reached on 13 July 2022 which combined the seventh/eighth reviews, extended the programme to 30 June 2023 and augmented the package by 750 million Special Drawing Rights raising Pakistan’s access to 7 billion dollars under the Extended Fund Facility programme, it would be safe to assume that the first batch of the eleven-party coalition government’s economic team leaders – Miftah Ismail and Murtaza Syed, Acting Governor of the SBP – fully satisfied the Fund on the status of implementation of the agreed conditions notably time bound quantitative action plans and structural benchmarks. This was acknowledged in the seventh/eighth detailed review documents which noted that: (i) the Pakistan authorities expressed concern about the then prevailing disorderly market conditions in the foreign exchange market. It is disheartening that the then economic team leaders, both qualified economists, failed to identify the banks involvement in creating these disorderly market conditions and it was Prime Minister Shehbaz Sharif who ordered an inquiry into the matter on 1 August 2022. On 23 January 2023 while holding a press conference to share the decision taken by the Monetary Policy Committee to raise the discount rate to 17 percent Governor Jameel Ahmed, when asked, admitted that the investigation was complete and added that the only issue left is what type of action be taken against windfall foreign exchange income earned by six banks – fiscal or regulatory. He repeated these two options during the National Assembly Standing Committee on Finance meeting on 9 March and sadly it is still unclear whether any action has been taken against the offending banks; and (ii) the Miftah Ismail-Murtaza team requested the Fund that the remaining exchange restrictions (documented in the review as limitations on advance payments for imports against letters of credit and advance payments up to a certain amount of the invoice without letter of credit for import of eligible items) be permitted till the new programme end of 30 June 2023 when balance of payment conditions permit; the Fund acceded to this request but advised that “more prominence should be given to exchange rate flexibility as a means to address balance of payment pressures rather than administrative and exchange measures.”

So what changed with the advent of Ishaq Dar as the country’s finance minister sent with the explicit mandate to strengthen the rupee-dollar parity after a five-year self-imposed exile by his party leader? Dar took credit for the rupee strengthening against the dollar in October 2022, the first full month of his fourth tenure as the country’s Finance Minister, without making any reference to the by then known conclusions of the inquiry report, claiming that the speculators knew how hard he would have come down on their illegal activity which is why he did not have to take any punitive measures.

By November 2022 the rupee began to lose value due to a visibly worsening economic impasse attributable to Dar’s flawed policies – extending subsidies to the elite with a 110 billion-rupee electricity subsidy to exporters while 33 million flood victims remained under the open sky, raising budgeted current expenditure by 75 percent compared to the year before funded by domestic borrowing with severe negative repercussions on growth rate and failure to reach a staff level agreement on ninth review that persists to this day. The rupee erosion led to the decision to control the interbank rupee-dollar parity – a decision violative of the agreement with the Fund to use exchange rate flexibility to address balance of payment pressures through continuing the policy of a market based rupee rate. The disastrous outcome of this was a widening disparity between the grey market and interbank market rates, prompting remitters to revert to the illegal hawala/hundi system that have cost the country 3.4 billion dollars in lost remittances (July-April 2023 in comparison to the comparable period of the year before), and stockpiling of containers at our ports with a painfully visible shrinking of the economy that, as expected, has hurt the poor and vulnerable much more than the rich.

Second, foreign exchange reserves held by the SBP have continued to plummet reaching a low of 4.457 billion dollars on 28 April 2023 that in turn places an inordinate pressure on the government to incur foreign loans/borrowings. During his previous tenure as finance minister Dar borrowed heavily from the foreign equity market at rates well above the international rate though lower than domestic rates and to add insult to injury proceeded to contain the budget deficit (the debt servicing of dollar denominated loans/equity) through controlling the rupee-dollar parity. And while he has been forced to abandon an unrealistic interbank rupee-dollar parity by the IMF as well as subsidy to exporters, yet there is a danger that he may revive these inane policies in budget 2023-24 at a prohibitive cost to the economy in general and poor and vulnerable in particular unless the IMF’s stalled review is declared a success and the ongoing budget exercise comes under its purview. His most recent salvo against the Fund notably that with or without the Fund support Pakistan will not default is limited to the end of the current fiscal year (30 June 2023) or less than six weeks from now.

Pakistan’s economy and the people need a voluntary massive sacrifice by the recipients of current expenditure (at least 1.5 trillion rupees less than what was realized under this head during the current year) as well as reforms in the pension system (another major recipient of current expenditure) that would slowly but surely increase leverage with donor agencies instead of engaging in the usual anti-poor practice of raising utility rates and indirect taxes whose incidence on the poor is greater than on the rich while upping current non-development expenditure whose recipients are largely the elite.

To conclude, Dar’s lack of economic know-how is well documented not only during his previous stints but also what he has cost the economy since taking oath on 27 September 2022. The current set of policies does not support the eleven-party coalition government’s persistent claim that it took economically challenging decisions at the cost of its political support – a factor that would lose the PML-N its support base in Punjab. It is still not too late to begin to make amends instead of allowing the country to be held hostage to a flawed perception held by the party supremo that Dar has the ability to turn the economy around.

Anjum Ibrahim, "Dwindling forex reserves and bravado," Business recorder. 2023-05-15.
Keywords: Economics , Consumer price , Domestic policy , Inflation rate , Budget deficit , International rate , political support , Foreign exchange , Ishaq Dar , PML-N

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