Foreign exchange reserves of the State Bank of Pakistan (SBP) plunged to $3.678 billion on January 20 from $4.601bn due to external debt repayments. At this level, the reserves provide imports cover of three weeks against a standard minimum of three months.

The SBP reported a new level of the forex reserves on January 26 and simultaneously removed the cap on the official exchange rate. Consequently, the rupee nosedived Rs255.43 to a US dollar in the interbank market from 230.89 a day earlier. Then on January 27, the central bank let the rupee fall further — this time to 262.6 to a dollar.

This unprecedented 13.7 per cent rupee depreciation within two days, undertaken to meet a key condition for the resumption of a stalled International Monetary Fund (IMF) loan, is expected to bridge the gap between the interbank and open market exchange rates.

The expected increase in remittances and export dollars will ease the pressure on the forex reserves, more so because the rise in the dollar value will help contain imports. This comes at a time when the SBP has promised to start easing restrictions on import payments as 5,700 containers of imported food, medicines and industrial raw materials remain waiting for clearance at Karachi Port.

Most of the lending to NBFIs will take several quarters before being channelled into productive sectors

From February-March, the country expects substantial inflows of dollars from the IMF and other international financial institutions as well as from three friendly countries — Saudi Arabia, UAE and China. That will be in addition to the post-flood relief packages promised by the world.

Some of those packages are short-term and can be expected to start coming in in February-March. But external debt payments due before the close of this fiscal year on June 30, 2023, are huge at about $8bn. This means the bulk of forex funds expected to come in (after the resumption of the IMF lending programme) will be consumed by external debt servicing.

That is so because despite all curbs on imports (despite a declining GDP), the overall trade deficit is expected to remain large enough to devour home remittances.

The phenomenal 13.7pc rupee depreciation follows a one percentage point increase in the central bank’s key policy rate announced on January 23. The interest rate hike — from 16pc to 17pc — was meant to contain inflationary pressures. But the massive rupee depreciation is bound to unleash a new — and most likely stronger — wave of price hikes. After making the exchange rate market-driven, the government will also raise the development levy on fuel and increase electricity and gas tariffs to meet the other two key conditions for the IMF loan. That will add further fuel to inflation, rendering monetary tightening ineffective against inflationary pressures.

The only objective that the higher interest rate will serve is to dampen further aggregate demand, which is otherwise declining after the last year’s super floods, political chaos at home and amidst a global economic slowdown. Industrial units are being closed or scaling back operations, and people are losing jobs daily.

One indicator of declining economic activity in the country is that private sector credit offtake this year remains too small. (The economy is set to grow just 2pc this fiscal year, down from 6pc last year). Furthermore, massive government borrowings from banks (Rs1.307 trillion in seven and a half months of FY23) are not channelled into productive sectors. Almost the entire amount of borrowing is being used to finance the fiscal deficit.

But banks’ net lending to Non-bank Financial Institutions (NBFIs) remains exceptionally strong. In about seven and a half months of this fiscal year (between July 1, 2022, and January 13, 2023), banks lent Rs213bn to NBFIs against just about Rs3.7bn in the year-ago period, according to the SBP.

The term NBFIs covers mutual funds, pension funds, asset management companies, Real Estate Investment Trusts, investment banks, leasing companies, Modarabas, non-bank microfinance companies and housing finance companies etc.

On the other hand, the entire private sector (minus NBFIs) got Rs410bn bank credit in seven and a half months of this fiscal year — substantially down from Rs787bn in the year-ago period.

The phenomenal growth in bank lending to NBFIs indicates the intensity of the financialisation of the economy in the absence of the desired real sector growth. Most of the bank lending to NBFIs will continue circulating within the financial sector — changing hands many times — and will take several quarters before being channelled into the productive domestic industry.

Published in Dawn, The Business and Finance Weekly, January 30th, 2023