Can SBP arrest the rupee fall?

For a poor country like Pakistan, which largely depends on imports, the fall of the rupee against the dollar produces multiplier effects in the economy. Increase in foreign debt and domestic inflation, rise in import bill, interest rates hike and increase in costs of production are some major shocks that the economy has to absorb in the backdrop of depreciation of the rupee in FY 12. The lower the vulnerability of the economy to absorb these shocks the higher the risk of failure for the economy.
The recent slide in the rupee to 91.30 against the dollar leaves economic pundits and businesses in dismay. The outlook for 2012 remains gloomy indeed. The rupee was traded around Rs62.00/$ in April 2008 and is trading around 91.30 in Jan 2012. Thus the currency has lost around 46 per cent of its value in nearly 4-years.
The slide of rupee may be attributed to unstable security situation in the country which accelerated the flight of capital and choked foreign investments-two extremely important sources which help provide a good base for foreign reserves to hold ground. Also the inflow of foreign aid/loans to the country has remained intermittent. Add to this picture, repayments the country has to make to the rest of world, have risen too. When reserves are limited, increasing foreign debt repayments coupled with rising import bill is making the task even more difficult for the SBP.
No doubt, whilst exports can benefit from the depreciation of the currency, the domestic economy on the other hand stands much to lose if the vulnerability is weak. As the local currency loses steam the cost of imports rises and if these are largely based on necessities (energy and food items), which in practice face inelastic demand, it will further stoke inflation.
Their savings, if any exist, evaporate gradually and the quality of life suffers and penury rises fast. This is a never ending cycle and if the SBP’s intervention, to stabilise the currency, is not timed well the economy might face perverse effects. The country is unfortunately caught in the same syndrome.
Foreign exchange reserves have already declined to $16.91b by Dec-end from a high of $18.31b on July 30, 2011. Besides regular import bill which might cross $37b mark in the FY 12, repayments of $1.2b to the IMF and total foreign debt payment $ 4.2b are also due. The current account deficit ballooned to $2.1b during July-Nov 2011 as against $589million in July-Nov 2010. The economy in FY 12 might need extra $12-15b to service its Balance of Payment deficit. If export earnings and home remittances were unable to generate much needed steam in FY 12, country’s reserves might come under extreme test and so might the currency.
The choice for Pakistani central bank thus gets limited to coddle the exchange rate in the backdrop of narrow and ever drying streams of foreign currency earnings and fast depleting reserves. Momentary interventions (such as selling of dollar in the open market and to banks) by the SBP could push the rupee slightly up but the long term movements of exchange rate will remain under pressure so long as outflows of dollar outpaced the inflows. Fast depleting reserves will force the SBP to rise from the bed and do something. Alas. ‘stillness and capitulation’ are perhaps the only options left with the SBP to see helplessly the fall of the rupee touching near 100 mark at the end of 2012.

The author is an Islamabad based freelance contributor and Director SZABIST, Islamabad campus. Views expresses herein are personal. He can be reached at [email protected]