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Old wine in old bottles

Reports indicate that Ishaq Dar’s selling point in being reappointed as the country’s finance minister for the fourth time was his claim that he could not only check the rupee depreciation but also reverse it as he had successfully managed it during his previous tenures as the Finance Minister.

The rupee has gained strength since Dar’s return to Pakistan on 26 September and of particular significance is the fact that the open market rate is now lower than the interbank rate. On 25 September the open market buying rate was 241.3 rupees to the dollar (a rate pushed up mainly by commercial banks picking up dollars in the open market and their sale at a higher rate to make windfall profits) against 239.4 interbank rate. On Friday, open market rate registered at 228 rupees to the dollar with interbank rate closing at 228.45 rupees to the US dollar.

The open market speculators in anticipation of a strengthening rupee, are offloading their holdings which is moving the market towards stabilization of the rupee. Once their holdings have been offloaded and the market stabilised possibly at around 220 to 223 rupees to the dollar the rupee will only strengthen if macroeconomic indicators improve. In the event that these do not improve the rupee will once again begin to erode.

The interbank rate is a market-based exchange system which allows the State Bank of Pakistan (SBP) to set a range which as per IMF (International Monetary Fund) general policy documents, may be adjusted by the central bank in the event of disorderly market conditions. That such conditions have prevailed in months past is acknowledged in the seventh/eighth IMF review dated September 2022 and given the appallingly low foreign exchange reserves (8.7 billion dollars after the recent disbursement of the Fund tranche which have further declined to 8 billion dollars today) the government, unable to throw dollars onto the market to strengthen the rupee, was forced to take other policy measures to reduce dollar demand and thereby strengthen the rupee that included: (i) payment authorization from SBP before initiating transactions for importing certain goods with approval granted in a discretionary manner and a ban on luxury items (partially abandoned due to IMF insistence that it was violative of the agreed Performance Criteria); (ii) Cash Margin Requirements introduced in April set to lapse in December 2022; and (iii) limitation on advance payments for imports against letters of credit and advance payments up to the certain amount per invoice (without LCs) for the import of eligible items. These restrictions, so pledged the government would be lifted as and when the disorderly foreign exchange market conditions respond to the complementary macroeconomic policies – macroeconomic policies that include extremely tight monetary and fiscal policies, anti-growth and highly inflationary) as well as reforms in the power and tax sectors.

In other words, for the rupee to sustain and indeed strengthen its recent gains macroeconomic indicators would have to improve – indicators which include reducing the trade deficit, rising inflows (ideally from desired earnings that include exports and remittances rather than external borrowing), easing inflation differential with our major trading partners, and moving towards a sustainable budget deficit.

Back in 1998 after the then government of Nawaz Sharif conducted nuclear explosions on 28 May in the Chagi hills of Balochistan in retaliation to India’s 11 and 13 May nuclear tests in Pokhran region the US responded by imposing sanctions on both India and Pakistan. In India capital inflows declined yet there was no panic as by end April 1992 its foreign currency reserves were 26 billion dollars (six months of imports). In addition, the sale of Resurgent India Bonds to non-resident Indians (NRIs) brought in over 4 billion dollars and by October India’s reserves exceeded April levels.

In marked contrast Pakistan at the time was heavily dependent on international capital flows (borrowings from bilaterals and multilaterals), a dependency that continues to this day. Total external debt and liabilities grew at an average 7.4 percent per annum during the 1990s – from 20.5 billion dollars in 1990 to 38.9 billion dollars by 1999. Desired foreign exchange earnings (exports and remittances) rose by a lot less during this period – about 4 billion dollars prompting the State Bank of Pakistan to conclude that “the debt burden (external debt and foreign exchange liabilities as a percentage of foreign exchange earnings) rose from 256.6 percent in 1989-90 to 335.4 percent in 1998-99.” In other words, Pakistan’s exposure to international capital markets was considerable while India’s was negligible and therefore there was little comparison between the outcome of the sanctions on India and Pakistan.

In 1997 the Sharif government made the rupee fully convertible, and allowed free movement of foreign currency in and outside the country, but in 1998 froze foreign currency accounts to forestall a run on the rupee, which led to withdrawals, capital flight and a decline in remittance inflows.

Dr Hafiz Pasha, as advisor to the Prime Minister on finance at the time during the World Bank/IMF annual meeting in October 1998 lamented the sanctions which he claimed “also affected our relationship with the international financial institutions. Even the Fund Program was put in abeyance despite Pakistan having met the performance criteria. This disruption in our normal financing has led to severe difficulties requiring emergency measures.”

On 7 November 1998 after intense diplomacy to head off a nuclear arms race in South Asia the then United States President Bill Clinton announced the lifting of the bulk of sanctions against India and Pakistan as a reward for steps towards nuclear control agreements as well as pledges to do more. In this favourable environment on the very same day Ishaq Dar was given the additional charge of the Ministry of Finance (in addition to Commerce).

With the sanctions lifted Dar began negotiations with the multilaterals, including the Fund. He envisaged heavier reliance on borrowing from external sources, agreed to reschedule outstanding debt and sought balance of payments support – a policy thrust that remains relevant to this day. On 28 December 1998 Pakistan went on yet another IMF programme which generated additional funds from bilaterals and other multilaterals, a given at the time that, disturbingly, is not a component of the ongoing programme as it requires rollover (7 billion dollars) and additional pledges by friendly countries (4 billion dollars) as a prerequisite for tranche approval.

The government also agreed at the time to abandon the fixed exchange rate policy and introduced a multiple exchange rate system – official rate (continued setting the rupee to the dollar), a floating interbank rate (a step towards a market determined exchange rate which in the ongoing IMF programme has been implemented), and a composite rate (combining the two).

The PML-N government was swept to power after the 2013 elections and in September 2013 the country went on yet another Fund programme. Low reserves at 6008.4 million dollars (not enough to meet three months of imports) was tackled, as in the past, by reengaging with the Fund for the 21st time. The rupee’s decline was arrested not through macroeconomic reforms but through external borrowing – from bilaterals (particularly a 1.5 billion dollar grant from Saudi Arabia early 2014), multilaterals, debt equity (issuance of sukuk/Eurobonds though the rate of return agreed was more than double the then prevalent international rate) and artificially propping up the rupee through periodic market interventions from borrowed funds (resulting in the biggest ever current account deficit inherited by the Khan administration of 20 billion dollars). The rupee at 105.5 to the dollar on 27 December 2013 strengthened to about 98 rupees by March 2014.

Today the country is poised for renegotiation on the agreed seventh/eighth review’s harsh conditions subsequent to the successful internationalizing of the need for assistance from bilaterals and multilaterals, particularly with the IMF, in light of the massive flood damage.

To conclude, an attempt to improve macroeconomic fundamentals has never been sustained and if implemented reversed quickly as elections loom on the horizon. The lure of diverting scarce resources to win elections rather than to implement macroeconomic reforms has made the economy more fragile with each passing year and accounts for its current tenuous state. One can only hope for a shift from political to entirely economic considerations, a pledge made time and again by administration after administration but implemented only to the extent of meeting IMF conditions to ensure a tranche release and quickly abandoned once elections were at hand.

Anjum Ibrahim, "Old wine in old bottles," Business recorder. 2022-10-03.
Keywords: Economics , State Bank , Monetary fund , Central bank , Ishaq Dar , Nawaz Sharif , Dr. Hafiz Pasha , Economy , Pakistan , India , IMF , SBP

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