The rupee’s decline, triggered by the nerve-racking political uncertainty unleashed by the sudden Cablegate-led dissolution of the National Assembly (NA) on April 3, stopped on April 8. And, the local currency also made some appreciable recovery against the US dollar.

Earlier, on April 7, a landmark Supreme Court (SC) judgment restored the dissolved NA and brought the weeklong political turmoil in the country to an end. Also on April 7, hours before the SC judgement, the State Bank of Pakistan (SBP) “in an emergency meeting” raised the interest rate by 250 basis points. The move was primarily aimed at containing inflation — 12.7 per cent year-on-year in March up from 12.2pc in February 2022.

What is next? The rupee’s quick recovery on April 8 is due, in large part, to the dollar selling by a few commercial banks on the insistence of the central bank. Can the SBP, with its forex reserves inadequate to cover even two-and-a-half months of merchandise imports bill, afford to intervene directly in the market? Obviously, the answer is no. Can the central bank persuade a commercial bank to sell dollars to rescue the rupee whenever it is under pressure? Again, the answer is no.

Forex market should return to its routine business from April 11. The central bank will have to ensure that the exchange rate remains “market-driven”. Will the rupee be able to regain more of its lost value? Or will it start losing again? That depends on two things: how the higher interest rate depresses demand for import-dollars and how much “hot money” higher returns on government bills and bonds attract foreign investors and overseas Pakistanis. That, in turn, depends on how soon a constitutional political order is restored and stabilised in the light of the April 7 SC judgement.

Demand-depressing effects of interest rate tightening will continue as an undercurrent which would mean lower-than-expected GDP growth for FY22

It is true that the political events in the country took a heavy toll on the rupee’s health last week but that was just one apparent, temporary reason. Fundamentally the rupee remains weak because of the external sector problem. Essentially, the problem is that outflows of dollars were exceeding their inflows and as a consequence, the country’s forex reserves were also declining. (And this was happening amidst accumulation in forex debts whose servicing has become a big drag on SBP’s forex reserves and has been at the root of all external sector issues— including the much-dreaded widening of the current account deficit).

In just four working days (between April 3 and April 7) the rupee lost 2.23pc value to the US dollar. But it had shed 1.26pc value against the dollar just a week earlier. The recovery the rupee made on April 8 brought its value back to 184.68 to the dollar, up from 188.18 to the dollar — its all-time low. But behind this “managed” sharp recovery remains the fact that the local currency has lost more than 17.2pc value against the dollar since the start of this fiscal year on July 1, 2021. Meanwhile, the SBP’s forex reserves have also declined to just $11.319bn (as of April 1) from $17.299bn at the end of June 2021.

For forex building, Pakistan is looking, once again, towards China hoping to attract placement of Chinese foreign funds into the SBP’s account or immediate forex support in any other form. Exports and remittances, two main non-debt creating forex inflows, are growing but are not enough to meet the country’s total import bill. Interest rate tightening cannot contain imports’ growth to the extent that export earnings plus remittances can pay for the overall import bill — not at least in the near future.

For saving the rupee from further, “unmanageable” decline all hopes are pinned on extremely tight interest rates — now 12.25pc up from 9.75pc before April 7.

But the problem is that the business community does not seem to have bought all the arguments of the central bank for a massive 250bps interest rate hike and a section of it wants the SBP to revisit its decision.

The SBP, on its part, has said more than once that is ready to revisit its monetary policy as and when the situation demands. It means that a little softening of the interest rate after some time cannot be ruled out. But before doing that the SBP will have to watch exchange rates and inflation behaviour and it might take months or at least a month.

The central bank will wait for the evidence of inflation moderating somewhat as a result of its full dose of monetary tightening. Inflation, on the other hand, has emerged as challenge number one to the global economy and cannot be expected to come down quickly in Pakistan. It is true that a 250bps hike in interest rate is enough to moderate domestic demand to some extent besides containing “imported inflation” to some extent.

But all this would take at least a few months. This means that the rupee would continue to remain under some pressure and inflation would remain in double digits during the last quarter of FY22, April-June 2022.

Demand-depressing effects on the interest rate tightening would continue as an undercurrent which would mean lower-than-expected GDP growth for FY22. The most recent estimate of GDP growth — 4pc — has come from the Asian Development Bank. But that estimate is based on the pre-April 3rd situation. The political turmoil in the country is bound to decelerate the economic growth at least during the current quarter and that means GDP growth of lesser than 4pc.

Below 4pc growth means more joblessness and double-digit inflation means lesser real income for the majority of the population. Tough times ahead!

Published in Dawn, The Business and Finance Weekly, April 11th, 2022