July 10, 2019 (MLN): The economic circle in Pakistan has been buzzing about the slip in real effective exchange rate (REER) of Pakistan, which as per International Monetary Fund (IMF) has fallen below 100 in May 2019.
While the information is true, we are at a fix to grasp why the news is suddenly catching fire when the same has been true for the past few months.
A little background on the matter: The State Bank of Pakistan (SBP) and International Monetary Fund (IMF) have different base years for the evaluation of REER and nominal effective exchange rate (NEER). Therefore, both administrations have different estimates for REER and NEER in Pakistan.
While the PKR is still over-valued according to SBP’s calculation (REER index at 102.6 as of May 2019), IMF’s calculations showed REER to fall below 100 back in December 2018. The rates went up to 100 in February and March before slipping below the benchmark once again in April and the latest figure that of May 2019 stands at 97.76.
This makes REER index’s fall below 100 a stale news and makes us wonder whether desperate times are now compelling analysts to take leave of critical thinking.
Our analysis on the subject shows that by highlighting the REER’s fall below 100 to give hopes on PKR’s ascent in future, the gossip mongers are barking up the wrong tree because a detailed analysis on this matter leads to a parallel conclusion.
Since December 2018, the REER calculated by IMF has come down by 1.35% while PKR has depreciated by 6.53%, from 138.86 per dollar to 147.93 per dollar.
Moreover, the currency depreciated by another Rs.12 in June 2019 which logically implies that the Fund’s REER index should come further down next month.
However, historical trends promise no such thing as the past months have recorded many such instances where despite depreciation, REER has gone up.
The question is, what is the implication of REER crossing the benchmark, on PKR’s future?
Under standard conditions, an undervalued currency would appreciate in near future so that it can be restored to its original value.
However, Pakistan is presently under a contract with IMF which compels it to keep its currency undervalued in order to promote exports.
This along with the fact that SBP’s data set holds PKR overvalued as of now, points towards the possibility of further depreciation in coming months.
On the other hand, keeping a currency artificially undervalued for longer period of time will induce trading partners to lower the value of their currencies in order to maintain balance in the long term.
In fact, what has also caught our attention in this regard is that Pakistan’s key trading partners, UK and Europe have also been losing out the value of their currencies to PKR lately which indicates how strong USD is globally, at present.
Since it’s not just PKR that is depreciating, it just might balance out the effect of its devaluation in the basket of currencies and thereby result in REER index declining less than expectation. In this case, chances of PKR appreciation are again placed on thin ice.
On another front, since Pakistan has been under the daunting spell of poor economic conditions for years now, its people have run out of patience. Under these circumstances, holding a position and taking stern measures for the greater good is proving to be difficult.
In a futile attempt to keep the nation motivated, the State Bank of Pakistan on Prime Minister Imran Khan’s insistence, allegedly intervened to appreciate rupee towards the end of June 2019. The SBP release on FX reserves shows they spent $500 million given by Qatar in less than a week.
Moreover, in response to a question from a panel of journalists recently, Prime Minister and his advisor on Finance, Revenue and Economic Affairs, Mr. Abdul Hafeez Shaikh said that PKR will not depreciate to Rs.180 per dollar, but in an independent market based purely on supply and demand, who are they to decide that?
It is pertinent to remind here that governor SBP stated in a press conference not long ago that the value of PKR will be based on supply and demand.
While the current account deficit has reduced from $17.93 Billion to $12.68, thanks largely to an increase in worker remittances and a slight decline in imports, the exports have remained stagnant.
Notwithstanding the heavy depreciation, the Trade deficit of Goods and services has only declined from $34.2 billion to $30 Billion in the 11 months of FY19, which means more needs to be done to discourage imports and stimulate exports.
Moreover, the trend from the recent trade numbers reveals that imports have started to pick up again, with the monthly trade deficit being the highest since August 2018.
On top of this, the IMF has revealed that Pakistan requires an additional USD 38 Billion to meet its loan obligations over the next 39 months.
Pakistan has received around USD 16 Billion in loans and credit in the last 12 months, yet it’s unable to build up its reserves, with the SBP reserves providing less than 45 days of import cover. This should serve as prelude to what the next 39 months will be like.
All this goes to show is that Pakistan’s economy is far from the position which would allow the Rupee to gain in strength, and regardless of where the REER Index is, PKR’s value, in a market based system, will remain far from stable..
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