The government has planned an extra cushion of $4 billion over the next 12 months to bolster Pakistan’s foreign exchange reserves position.
The funding commitment is being arranged through several channels, including from friendly countries that helped Pakistan at the beginning of the International Monetary Fund’s (IMF) program in June 2019. This was briefed in a joint statement called ‘Pakistan’s Strategy for Navigating FY2023: Five Important Facts’ that was released by the Ministry of Finance and the State Bank of Pakistan (SBP).
In FY23, Pakistan’s gross financing needs will be more than fully met under the ongoing IMF program. The financing needs stem from a current account deficit of around $10 billion and principal repayments on the external debt of approximately $24 billion, the statement said.
Pakistan’s Problems are Temporary, Being Resolved Forcefully: MoF, SBP
The Ministry of Finance and the SBP have released a joint statement on the reasons behind the prevailing situation of foreign exchange reserves and the rupee depreciation against the dollar, and the expected improvement of these macroeconomic indicators with the scheduled inflows of the International Monetary Fund (IMF) in the coming weeks.
The joint statement read, “Going forward, as the current account deficit is curtailed and sentiment improves, we fully expect the rupee to appreciate. Indeed, this was the experience during the beginning of the IMF program in 2019, when the rupee strengthened considerably after a period of weakness in the lead-up to the program.”
The rupee can overshoot temporarily, as it has done recently. However, it moves both ways over time. We expect this pattern to re-assert itself in the coming period. As a result, the rupee should strengthen in line with improved fundamentals in the form of a smaller current account deficit and stronger sentiment, it said.
Reasons Behind the Depletion of Foreign Reserves and the Rupee’s Freefall
The statement detailed that Pakistan’s foreign exchange reserves have fallen since February as foreign exchange inflows have been outpaced by outflows. The inflows mainly comprise multilateral loans from the IMF, the World Bank, and the ADB; bilateral assistance as deposits and loans from friendly countries like China, Saudi Arabia, and the UAE; and commercial borrowing from foreign banks and through the issuance of Eurobonds and Sukuks.
The paucity of inflows has happened, in large part, due to the delay in completing the next review of the IMF program, which has been pending since February due to policy slippages. Meanwhile, on the outflows side, debt servicing on foreign borrowing has continued as repayments on these debts have been due over this period.
At the same time, the exchange rate has come under significant pressure, especially since mid-June. It has been driven by general US Dollar tightening, a rise in the current account deficit (exacerbated by a heavy energy import bill in June), the decline in foreign exchange reserves, and worsening sentiment due to uncertainty about the IMF program and domestic politics.
However, important developments have happened recently that will address both of these temporary issues. On July 13, the critical milestone of a staff-level agreement on completing the next IMF review was reached. As of today, all prior actions for completing the review have been met, and the formal meeting of the board to disburse the next tranche of $1.2 billion is expected in a couple of weeks.
At the same time, macroeconomic policies — both fiscal policy and monetary policy — have been appropriately tightened to reduce demand-led pressures, and rein in the current account deficit. Finally, the government has clearly announced that it intends to serve out the rest of its term until October 2023 and is ready to implement all the conditions agreed with the IMF over the remaining 12 months of the IMF program.
Measures to Contain Current Account Deficit
In addition to high global commodity prices, the large current account deficit in FY22 was driven by rapid domestic demand (growth reached almost six percent for two consecutive years leading to the overheating of the economy), artificially low domestic energy prices due to the February subsidy package, an unbudgeted and procyclical fiscal expansion, and heavy energy imports in June to minimize load-shedding and build inventories.
To contain this deficit going forward, the policy rate was raised by 800 basis points, the energy subsidy package has been reversed, and the FY23 budget targets a consolidation of nearly 2.5 percent of GDP, centered on tax increases while protecting the most vulnerable. This will help control domestic demand, including fuel and electricity.
In addition, temporary administrative measures have been taken to contain the import bill, including requiring prior approval before importing automobiles, mobile phones, and machinery. These measures will be eased as the current account deficit shrinks in the coming months. These measures are working: the import bill fell significantly in July, as energy imports have declined and non-energy imports continue to moderate.
Foreign exchange payments in July were significantly lower than in June. This is true for both oil and non-oil payments. Altogether, payments were a sustainable $6.1 billion in July compared to $7.9 billion in June.
The latest trade data indicate that non-oil imports continue to fall. Specifically, non-oil imports fell by 5.7 percent quarter-on-quarter during Q4 FY22. They are expected to reduce further going forward.
Looking ahead, a considerable slowdown has been observed in Letter of Credit (LC) openings in recent weeks, again for both oil and non-oil commodities. Based on market reports, there was an 11 percent month-on-month decline in Oil Marketing Companies’ sales volume in June.
After the surge in energy imports in June, a stock of diesel and furnace oil sufficient for five and eight weeks, respectively, is now available in the country, much higher than the normal range of two to four weeks in the past. This implies a lower need for petroleum imports going forward.
With the recent rains and storage of water in the dams, hydroelectricity is also likely to increase, and the need to generate electricity on imported fuel is expected to decline soon. As a result of these trends, the import bill is likely to shrink going forward and should begin to manifest itself more forcefully in lower FX payments over the next one to two months.
Overall, imports are expected to decline in the coming months due to a decline in global commodity prices, the higher oil stock, the unfolding impact of higher domestic prices of petroleum products, adjustments in electricity and gas tariffs, the removal of tax exemptions under the FY23 budget, administrative measures are taken to curtail imports, and the lagged impact of the monetary and fiscal tightening that has been undertaken.
Rupee to Regain Value
The rupee has overshot temporarily but it is expected to appreciate in line with fundamentals over the next few months. Around half of the PKR depreciation since December 2021 can be attributed to the global surge in the US dollar, following historic tightening by the Federal Reserve and heightened risk aversion.
Of the remaining half, some are driven by domestic fundamentals. In particular, the widening of the current account deficit, especially in the last few months. As stated above, the deficit is expected to narrow as things progress as the temporary surge in the import bill is brought under control. As this happens, the rupee is expected to gradually strengthen.
The remaining depreciation has been overdone and driven by sentiment. The Rupee has overshot due to concerns about domestic politics and the IMF program. This uncertainty is being resolved so that the sentiment-driven part of the rupee’s depreciation will also unwind over the coming period.
Where the market has become disorderly, the State Bank has stepped in through the sales of US dollars to calm the markets and will continue to do so, as needed in the future. Strong steps to counter any speculation have also been taken, including close monitoring and inspections of banks and exchange companies. Furthermore, additional measures will be taken as the situation warrants.
Rumors that a particular level of the exchange rate has been agreed with the IMF are completely unfounded. The exchange rate is flexible and market-determined and will remain so but disorderly movements are being countered, the statement concluded.
