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Pakistani rupee: a wayward currency

Hard currencies like the US dollar, Euro, pound, are independent free floats, and their value contingent on demand and supply which may fluctuate daily. However monetary authorities, be it a central bank/US Federal Reserve, routinely monitor exchange rate movements and may decide to take mitigating policy measures in instances when the economy is over-heated or the intent is to make exports more competitive though these hard currencies do not have an explicitly stated nominal anchor.

A market determined exchange rate is not an independent free float and is defined as a managed float with no predetermined path for the exchange rate though it is allowed to fluctuate within a monetary policy framework inclusive of establishing floors for international reserves, ceiling for net domestic assets, and foreign exchange reserves.

Neither an independent free float nor a market determined exchange rate reflects economic fundamentals as it may be driven by sentiments in the financial market or speculators who hold the view that a currency is going to rise in future and demand more of that currency today in anticipation of making a profit.

Pakistani rupee was a managed float, linked to a number of hard currencies, prior to 2019 when the then government authorities agreed to implement a market determined exchange rate under the International Monetary Fund’s (IMF) Extended Fund Facility (EFF) programme. The Pakistan Tehreek-e-Insaf government did not violate this agreement and neither did the first economic team leaders of the Shehbaz Sharif-led government – Miftah Ismail as Finance Minister and Murtaza Syed as acting Governor State Bank of Pakistan (SBP). But soon after this team reached the EFF’s seventh/eighth staff level agreement (SLA) on 13 July 2022 the rupee began losing value at an alarming rate: the lowest monthly rate was 239.25 in August 2022 and the lowest rate in September was 240.7.

Inexcusably neither of the two economic team leaders ordered an inquiry into the causes of the rupee depreciation and it was the then Prime Minister Shehbaz Sharif who ordered an investigation which held speculative activity by eight banks liable – an activity that reportedly netted the banks around a 100 billion-rupee windfall profits.

The incumbent Governor SBP Jameel Ahmed (appointed on 26 August 2022) named seven out of the eight banks during the Standing Committee on Finance and Revenue meeting on 4 October 2022 and contended that show-cause notice had been issued to three banks in the first phase while the rest would be investigated in the second phase. He did not clarify why he did not name one bank, what determined the selection of banks for the first phase or why all the eight banks could not be issued show cause notices concurrently.

On 19 January 2023 Ahmed again pledged to take action against banks involved in dollar manipulation within their foreign exchange operations. During Standing Committee on Finance and Revenue in-camera session dated 8 March 2023 Ahmed reportedly reiterated that Ishaq Dar, the then finance minister, wanted to levy a windfall profit tax on the banks, however, according to him, the IMF was opposed to this move. The Finance Act 2023 inserted section 99D in the Income Tax Ordinance 2012 allowing the government to impose a windfall tax on banks’ income, profits and gains during 2021 and 2022. However, it was not until 14 November 2023, a day before the IMF team issued a press release that a SLA on the first review of the Stand-By Arrangement (SBA) had been reached, that the Caretaker cabinet announced a 40 percent windfall tax on all banks’ profits with no additional tax or penalty on the eight offending banks

Ishaq Dar after his appointment as the finance minister on 27 September 2022 began implementing the economically flawed policy of controlling the interbank rate, thereby abandoning the market determined exchange rate which led to IMF’s sustained refusal to reach a staff level agreement on the ninth EFF review. The Stand-By Arrangement (SBA) with the Fund brokered by the then Prime Minister Shehbaz Sharif replaced the EFF with the prior condition to return to a market determined exchange rate.

On 7 September 2023 a crackdown commenced on currency speculators, accounting for the rupee appreciating vis a vis the dollar to reach a high of 275 – a strengthening that led CNBC to report that the Pakistani rupee rebounded from an all-time low of 307 rupees to the dollar (interbank rate with the open market rate at nearly 330 rupees to the dollar) to 275 rupees to the dollar mid-October 2023.

The rupee then began to weaken less than a week before the scheduled arrival of the IMF mission for the first review of the SBA on 3 November, which was declared a success on 15 November 2023 as per schedule. Tellingly, the press release issued by the Mission leader noted “returning to a market-determined exchange rate” instead of maintaining or sustaining a market-determined exchange rate and proceeded to note that the authorities “plan to strengthen the transparency and efficiency of the Forex market and to refrain from administrative actions to influence the rupee.” The choice of words indicates that the Fund mission had perhaps argued that the crackdown on speculators may have gone beyond the objective to end speculative activity and towards controlling imported inflation.  Since the departure of the IMF mission the rupee has begun to strengthen again, and the rationale being provided is that this is in the aftermath of the IMF SLA on the first review – a rationale that was not applicable after the seventh/eighth review of the EFF.

The SLA documents have yet to be uploaded on the Fund website which makes the SBA 30 June document’s programme exchange rate of 286.7091 rupees still relevant. The dollar rupee parity interbank (offer) this Thursday past was 285.45 and in the open market 286, close to the IMF programme projection and hence not a source of concern. Additionally, a continuous structural benchmark in the SBA document is to “ensure that the inter-bank open market premium remains within a plus/minus 1.25 percentage range.” The reason “Staff emphasized that a functioning flexible exchange rate market should be the means to address balance of payment pressures, rather than administrative and exchange measures.”

To conclude, there is little doubt that the authorities would like the rupee to strengthen against the dollar as it would reduce imported inflation. However, it is obvious that the Fund is averse to interbank exchange rate manipulation either: (i) a la Ishaq Dar style defined as setting a rate that cannot be supported due to appallingly low foreign exchange reserves, giving rise to multiple rates that led to 4 billion dollar reduction in remittance inflows last fiscal year; or (ii) a Caretaker crackdown on market speculators that raised concerns prompting the use of the word “returning’ by the Fund staff in the staff-level agreement dated 15 November 2023.

Anjum Ibrahim, "Pakistani rupee: a wayward currency," Business recorder. 2023-11-27.
Keywords: Economics , Exchange rate , Foreign exchange , Financial market , Interbank exchange , US dollar , Shehbaz Sharif , Ishaq Dar , CNBC , IMF , SLA , SBA

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