The rupee lost 16.8 per cent of its value to the US dollar in July. But it regained 6.4pc in just five working days of August. This happened as exchange-rate positive news poured in and the central bank took action against currency speculators, banks and exchange companies.

The acting Governor of the State Bank of Pakistan (SBP) Dr Murtaza Syed told a gathering of business leaders on August 3 in Karachi that the rupee is still “undervalued.” He would not say, however, what he thought was the actual value of the rupee and how would it reach that level. The rupee shot up to 224.04 to a US dollar on August 5 in the interbank market from 239.37 a week earlier.

This healthy development and the SBP chief’s remarks about the rupee have enlivened hopes among many. They hope it would continue its winning streak and could rise to as high as 180-190 to a dollar within months.

But all hopes are not necessarily built upon facts. It is true that in July, and during the April-June quarter, the rupee had lost part of its value against the US dollar due to speculation and currency smuggling amidst the growing political instability in Pakistan. But our external sector’s weaknesses (a huge current account deficit of $17.4 billion in 2021-22 ending in June and growth in external debts earlier necessitating increased external debt servicing) were the two primary reasons for the rupee’s colossal losses against the greenback.

The tenuous recovery of the rupee is highly contingent on the trade balance which in turn is influenced by global economic trends

Pakistan’s imports of goods fell 12.8 pc to $4.861bn in July this year from $5.575bn in July last year. Exports of goods declined by about 5.2pc, from $2.43bn to $2.219bn, according to the Pakistan Bureau of Statistics (PBS). Consequently, the trade deficit in July 2022 shrank 18.3pc to $2.642bn from $3.235bn in July 2021.

However, even the reduced trade deficit is huge. And, one month’s data is insufficient to project that the deficit for the full fiscal year will contract sharply. Besides, even this monthly trade deficit of $2.64bn exceeds the monthly average of remittances. This means that in this fiscal year as well, the combined earnings of merchandise exports plus remittances cannot cover the entire goods’ imports bill. What does that mean? That means that the current account deficit will remain in place.

Movements in demand and supply-driven exchange rates will continue to depend on the rate at which the current account deficit grows month after month.

Keeping this in view the recent appreciation of the rupee must not be taken as a sign of the rupee becoming stronger and being able to hold the ongoing rising trend for long. The rupee’s massive depreciation in July was primarily due to structural weaknesses of our external sector and the rise of the greenback in the international market. But political instability, polarisation, currency smuggling and flight of capital, delay in the outcome of Pakistan’s negotiations for the resumption of the International Monetary Fund loan and all such exchange-rate negative news and sentiments also contributed to its fall.

Its recent recovery owes more to the reversal of some of the exchange-rate news and sentiments and an obviously overdue correction in dollar-rupee parity than any real inflows except for the rollover of the Chinese commercial loans and state-level placement of funds. Together that amounts to $4.3bn and it was precisely due to these roll-overs that Pakistan managed to hold its foreign exchange reserves at the level where they are.

Forex reserves held by the SBP stood at $9.816bn at the end of June but despite the roll-overs of Chinese loans sank to $8.385bn on July 29.

This amount of reserves is equal to a little more than one and a half months of goods’ imports. But going forward, as imports begin to grow more reserves would be required even to keep the one-and-a-half months’ import cover.

Will imports grow in the coming months? Yes, of course. But how fast they grow depends primarily on three factors. First, international fuel oil prices and the pace of domestic economic growth. Second, global food commodity prices, local consumer and industrial demand for imported food items and raw materials — and the level of growth in domestic agriculture. And thirdly, overall economic growth at home particularly the performance of industries and exports.

Most importantly the course of global economic activity will have a big impact on all other factors listed above. After two quarters of negative economic growth, the US economy is technically in recession (though economists in the US and elsewhere debate intensely whether this rule of thumb is enough to define it as a recession or should the world wait for further proof).

If the US recession remains short-lived and its spillover impact on the global economy remains limited, then the volume of imports into Pakistan cannot decline much from where they are. (Past trend shows they will rather increase. Imports in the first month of the fiscal year remain low).

High economic growth of 6pc in 2020-21 is still having its spillover effect on various sectors of the economy and despite all the interest rate hikes and fiscal belt-tightening, domestic demand cannot be cooled off beyond a certain limit.

If volumes of imports grow then that would wipe off the benefit of lower international fuel oil and food commodity prices. Besides, it is uncertain whether the recent declining trend in fuel oil and food commodity prices will hold throughout our current fiscal year ending in June next year.

Published in Dawn, The Business and Finance Weekly, August 8th, 2022