The ‘market-determined’ exchange rate has led to a free fall of the rupee. The State Bank of Pakistan (SBP) is apparently reluctant or unable to intervene in the volatile currency market, possibly for two reasons.

The shrinking foreign exchange reserves, which have dropped from $10.5 billion in March to $7.28bn on June 21, have restricted the central bank’s capacity to curb speculative activity. And as media reports suggest, the International Monetary Fund (IMF) wants the rupee to slide to meet its stipulated target for rupee-dollar parity.

However Prime Minister Imran Khan was quoted by a TV channel on July 1 as saying that the IMF has not fixed the exchange rate and ‘the money launderers were behind the dollar hike’.

Without the SBP intervention, the market has continued to discover new equilibriums after short intervals as dollar’s demand and supply fluctuates. Taking notice of this trend, Imran Khan shared his concern about the sinking rupee with the State Bank Governor Dr Reza Baqir. That precipitated the required SBP intervention on June 28.

A fiscal expert suggests that the country’s finance team should develop an alternative plan to meet the IMF conditions incorporating as much as is doable

However, the Ministry of Finance says the central bank is independent and it has nothing to do with devaluation.

Since May 2018, the rupee has depreciated from Rs121 to lowest ever Rs164 to a dollar on June 26, 2019.

The local currency recovered at Rs159 when the SBP finally intervened. In his press conference only ten days earlier (on June 17) Dr Baqir had held out the assurance that if there was unusual volatility in the market, the SBP would act. It did act but with the prime minister’s support.

Dr Baqir had also stated on June 17 that the SBP had met all preconditions set by the IMF which was assumed by many as a message to the market that the rupee would remain stable for some time at least. The prior actions required by the Fund to be met by the SBP were essentially exchange rate and policy rate.

‘It was the free float of the rupee,’ said critics who felt the need for strong central bank oversight on exchange rate movements in a developing country like dollar-starved Pakistan. The banks and currency dealers were being allowed to make a windfall, they argued, while a fast depreciating rupee was fuelling fiscal instability. The fiscal deficit is already at a high 7.1 per cent with the latest forecast for this fiscal year at 7.2pc.

Fiscal experts fear that exchange rate volatility will adversely impact next year’s budget. The budget estimates are reportedly based on Rs150 per dollar parity both for debt repayments and customs revenues. When asked how the depreciating rupee (in excess of Rs150 to a dollar) will impact the budget estimates, advisor on finance Dr Abdul Hafeez Shaikh evaded a direct response and said “my answer is that the finance minister should not speak on the exchange rate.”

The debt servicing cost may exceed the estimated Rs2.9 trillion for the next fiscal year owing to continuing rupee depreciation and the SBP policy rate hike, both of which are linked to the increasing rate of inflation.

The inflation rate, now at 8.9pc, is expected to be considerably higher at about 13pc during the course of this fiscal year. This would make cutting government expenditures, as stipulated in the budget, more challenging.

According to another press report, the revenue target of Rs5.5tr for the next fiscal year was set by the financial team based on the assumption that the Federal Board of Revenue would meet the revised estimate of Rs4.15tr in 2018-19. The actual collection was much lower.

It would be hard for the finance ministry to achieve the primary budget deficit target. A fiscal expert suggests that the country’s finance team should develop an alternative plan to meet IMF conditions incorporating as much as is ‘doable’.

Former Finance Secretary Dr Waqar Masood Khan said “the cost of frequent and unpredictable changes in the exchange market is prohibitive… markets have been jolted and investor confidence has been shaken. With such volatility, who would even think of making investments, given that the cost of plant and machinery has gone up by 17pc in the last six weeks. The stability in the forex market would therefore remain a goal of the central bank”.

And owing to high interest rates, there would be a sharp decline in private sector credit. Deeply disappointed Mr Khan regrets, “we are constrained to say that a promising build-up of the IMF programme is losing steam before it begins.”

The State Bank’s exchange and policy rate polices do not appear to be contributing to financial stability while its autonomy needs work for growth with stability.

Published in Dawn, The Business and Finance Weekly, July 8th, 2019