The rupee made a slight gain in the inter-bank market and a larger recovery in the open market after the July 25 elections. But how soon can the exchange rate fundamentals be expected to improve to sustain this temporary rupee rise?

As expected, China has agreed to pour in some extra foreign exchange on top of the China-Pakistan Economic Corridor (CPEC) funding and the rupee rise is being linked to this. The size of official inflows is $2 billion. Of this, $1bn has already come into our accounts, top bankers say while confirming media reports.

Now let’s have a look at where we are as on July 27: the rupee has shed 5.2 per cent value against the dollar in the first month of the new fiscal year (up to July 27) after losing about 15.9pc in 2017-18. The central bank’s foreign exchange reserves are $9bn, sufficient to cover imports of only 47 days, annual exports are $23.2bn against imports of $60.8bn and the trade deficit is $37.6bn or more than 160pc of exports.

The PPP and PML-N governments failed to rein in fiscal deficits during their five-year stints in power

The current account deficit is $18bn, or twice the central bank’s foreign exchange reserves. The projected external sector financing gap for 2018-19 is $11bn, a sum so big that a fresh International Monetary Fund (IMF) loan will not suffice — unless the IMF is extra kind on the newly elected Pakistan Tehreek-i-Insaf (PTI)-led government in its first year in power.

How our newly elected government handles a precarious external account situation will depend on several factors, including how quickly it can fix fiscal issues. Past governments of the PPP and the PML-N generally failed to rein in fiscal deficits during their five-year stints in power. In the last fiscal, this deficit is estimated to have reached 7pc of gross domestic product. Our current enormous external account deficit is one of the many ramifications of the previous fiscal mismanagement.

Moody’s, one of the top three global credit rating agencies, warns in its post-election note on Pakistan that “heightened external vulnerability” is a main challenge for the new government. “Possible policy options would include monetary and fiscal policy tightening, further exchange rate depreciation and turning to the IMF for external financing,” it opines.

Going to the IMF for an immediate bailout is an option that the new government can exercise. But that alone would not be enough. We will need a mix of everything from hauling in foreign exchange hoarded abroad to borrowing from other international financial institutions, seeking foreign commercial loans, launching sovereign bonds and issuing dollar-denominated certificates of investment for overseas Pakistanis.

Every item listed above is under consideration at the Ministry of Finance, says a well-placed source. “We need to do something urgently before end-quarter external debt servicing in September.”

The need for doing something led to serious efforts on the part of the caretaker government installed to oversee the July 25 elections. Pakistan managed to get additional funding from China to fix its balance-of-payment issues.

Meanwhile, in order to manage the health of the rupee, the State Bank of Pakistan (SBP) has recently imposed some restrictions on import financing to keep the foreign exchange market liquid enough for smooth day-to-day operations. But the efficacy of these restrictions, aimed at plugging holes in the foreign exchange payment as well as slowing down the daily average outflows from the foreign exchange market, is yet to be tested.

Natural growth in the import bill is so rapid due to ongoing CPEC projects and on the back of a 5.8pc economic growth rate that recent steps taken to contain import financing cannot be expected to cut foreign exchange demand dramatically.

On July 16 and 20, the SBP made two separate moves: the first allowed import financing of 131 categories of items only against 100pc cash margin and the second restricted import payments “on open account basis” only to manufacturing and industrial users of spare parts and raw materials. Bankers say the twin measures can decelerate growth in import financing just marginally and that too for the time being without a net impact on total imports in the long run. Their guesstimates about the expected fall in our annual import bill of $60bn-plus as a result of these two limitations vary in the range of $1-2bn.

Going to the IMF for an immediate bailout is an option that the new government can exercise. But that alone will not be enough

Demand for dollars is not soaring solely due to imports. External debt servicing, outward foreign exchange repatriation by multinationals and their employees, outflow of foreign portfolio investment and financing of our people studying abroad, citizens going for Haj or getting medical treatment outside Pakistan or just touring foreign lands — all continue to fuel demand for foreign exchange.

In the last fiscal year, foreign direct and portfolio investors took out of Pakistan $2.3bn in profits and dividends, up from $2.1bn a year ago.

Part of the overall foreign exchange demand in the country is met through foreign exchange companies operating in the open market. But then foreign exchange selling by such companies to people financing education or medical treatment abroad of their loved ones in turn reduces their ability to sell the currency in the inter-bank market.

With sources of non-debt creating foreign exchange inflows — exports and home remittances — not growing fast in terms of volumes vis-à-vis imports, “the situation is quite challenging”, says the head of a local foreign exchange company.

“Gone are the days when people kept hard currencies as an investment and we bought the same from them whenever the rupee would slide. Only illicit money is now kept in hard currencies only to be smuggled physically elsewhere.”

Within two working days after the elections, the rupee recovered 46 paisa against the dollar in the interbank market and closed at Rs127.86 on July 27. In the open market, it made a much larger gain, Rs1.70 per dollar, and closed the day trading for selling at Rs128.30.

“Of late, the central bank has been warning foreign exchange companies to narrow the difference between inter-bank and open market exchange rates. The post-election fall in dollar rates means foreign exchange companies finally heeded to this warning,” says the treasurer of a large local bank. “Besides, the open currency market reacts more to temporary relief like the reported additional inflow of foreign exchange from China. That much is obvious.”

Published in Dawn, The Business and Finance Weekly, July 30th, 2018