Keeping exchange rates stable during this fiscal year is quite difficult because the country’s external debt remains high. It calls for setting aside large sums of foreign exchange for debt servicing while the country’s ability to earn net foreign exchange inflows is limited.

Total external debt and liabilities now stand at $112.8 billion. In the last fiscal year, Pakistan spent $11.9bn, or more than half of its total export earnings, on external public debt servicing.

The ongoing straightening of the entire foreign exchange regime to get out of the Financial Action Task Force (FATF) grey list and the continuation of the State Bank of Pakistan’s (SBP) policy to not intervene in the foreign exchange market (except to check extreme volatility) leave no room for artificially stabilising the rupee. So in coming weeks and months, changes in external-sector fundamentals — and their immediate and methodically-projected future impact on the foreign exchange market — will move exchange rates decisively.

In July, Pakistan’s current account saw a surplus of $424 million against a deficit of $613m in July 2019. But this good news failed to make an impact on the rupee’s health because the market knows that there is not as much substance in it to indicate net larger foreign exchange inflows in the near future. But two things are encouraging: however small it is, the current account surplus of July has coincided with a noticeable shrinking in the overall balance-of-payments deficit. It shrank to $241m last month from $751m a year ago.

Once imports start growing, the consequent increase in demand for dollars may bring the rupee under pressure

A current account surplus with no squeeze in the balance-of-payments deficit could have depressed optimism about the chances of a real improvement in the external account. To this extent, both current account surplus and the squeeze in the balance-of-payments deficit are hope builders.

But sustaining the current account surplus and minimising or eliminating the balance-of-payments deficit requires (1) consistent higher net foreign exchange inflows and (2) slower accumulation of the external debt to keep external debt servicing requirements from growing. This will take more time and hard work. The current account surplus is attributable chiefly to an exceptional rise in remittances due to Baqra Eid and the repatriation of savings by overseas Pakistanis who lost jobs in host countries amidst a Covid-19–triggered recession. The shrinking of the balance-of-payments deficit, on the other hand, occurred on the disbursement of an IMF loan tranche.

Unless exports and remittances show consistent high growth over coming months, sustainability of the current account surplus will remain doubtful. And unless foreign exchange inflows through these two non-debt–creating sources plus foreign direct and portfolio investments consistently post big volumetric gains, a reduced balance-of-payments deficit will be hard to maintain.

The PTI government is determined to maintain and even increase a 5pc growth rate of exports achieved in July. It hopes a bounce-back in the industrial output that slumped 10pc in 2019-20 and incentives given to exporters will make it possible.

The government is also confident remittances will continue to grow fast even amidst the global recession. In this regard, policymakers are pinning hopes on the recently introduced Roshan Digital Accounts scheme for the Pakistani diaspora. The scheme allows overseas Pakistanis to open rupee- or dollar-denominated accounts in eight Pakistani banks and use the same for investing in equity and debt markets while sitting abroad. The idea is to encourage them to send additional foreign exchange back home through formal channels. The government is expecting that “foreign investment by overseas Pakistanis” in its short-term debt papers will remain in the system for long, reducing our dependence on foreign portfolio investors.

In the recent past, huge foreign investment made in Pakistan’s short-term treasury bills flew out as the central bank’s rapid monetary easing reduced the once-lucrative returns on treasury bills.

To make this happen, the government is planning to roll out short-term debt papers denominated in both local currency and dollars exclusively for overseas Pakistanis who open Roshan Digital Accounts. It is too early to comment on whether this scheme will be a success and if so how much additional foreign exchange it will bring back home.

Though the SBP is hopeful about the success of the scheme, as one can easily conclude from a recent interview of Governor Reza Baqir to Bloomberg, the central bank cannot employ optimism as a tool in managing exchange rates. At the end of the day, it will have to ensure that the interbank foreign exchange market is sufficiently liquid ahead of scheduled external debt servicing. And it will have to ensure that the market squares off all routine transactions on a daily basis without creating extreme volatility. On top of all, the SBP will have to maintain its foreign exchange reserves at a level equal to, or higher than, three months of the import bill. A fall in the reserves below that level will signal the markets that the foreign exchange crunch is back.

Besides, the current situation on the Eastern border and dramatic developments in the region demand that the central bank should maintain foreign exchange reserves at a level that can satisfy the political leadership and the military establishment. This effectively means the SBP will have to limit even those interventions that it makes in the foreign exchange market to smooth out “extreme volatility in exchange rate”.

The exchange rate management is going to remain really challenging during this fiscal year. What else is going to make it even more challenging? An economic revival, after the last year’s 0.4pc contraction, requires an unavoidable growth in imports.

And once imports start growing, the consequent increase in demand for dollars may bring the rupee under pressure. The Ministry of Finance and the SBP are making some joint efforts to reactivate the once-neglected currency swap arrangement between Pakistan and China. If that arrangement becomes operational and is supported by banks and businesses alike, the exchange rate management can become a bit easier for the central bank.

The exchange rate–related headache can further be reduced if Pakistan can renegotiate the oil-on-credit facility with Saudi Arabia for a longer term. Ground realities of rapidly changing geopolitics have made it a Herculean task. Let’s hope for the best.

Published in Dawn, The Business and Finance Weekly, September 1st, 2020