Rupee strikes back

Myth versus reality

When the finance minister was under the spotlight, and headlines were written about the rupee’s free fall just a few months ago, it was indeed inconceivable that he may actually come back and prove everyone wrong by making the rupee rise against dollar. Even the most ardent of minister’s fan was not expecting the dollar to lose its glitter and slide with such comfortable ease. Whatever, he actually did deliver or is there something else to credit for the miraculous recovery and the inconceivable dollar drop.

Why did rupee shed its value against dollar in the first place?

Briefly we make our rupee attractive using short and long term economic levers. If the economy is doing well, Rupee is a darling, and if the economy is struggling then its value drops against other currencies mainly dollars. The State Bank of Pakistan (SBP) which will through its mechanism ‘manage’ the rupee depreciation wants to keep rupee competitive and not attractive.

In order to understand whether the current trend is sustainable or not, it is important to understand why the rupee did not recover so spectacularly a few months or some years ago? Rupee needs to devalue against the currencies and it is only natural it should do so – why? The possible reasons are listed below.

IMF wanted devaluation

Pakistan has been a frequent visitor of the IMF for fixing its current account deficits, and cash-starved economy. The IMF loans are arranged or renegotiated when either a political government is exiting or a new one is swearing in, and the reasons are equally interesting. The terms of these loans are frontloaded and have forced the government complaining and groaning in private at the way Fund forces these conditions.

One of the most important conditions is tight fiscal discipline, and achieving export targets. The Fund wants exports to grow, at the expense of other economic variables. These exports bring revenues and pays for the fund’s installments. The Fund has been a regular savoir or option of last resort since late 1987s and so when the government opted for the Fund they exactly knew what was stored in for us. Hence the rupee depreciation few months ago was exactly what funds wanted political government to do, that being to make sure that the rupee depreciated enough to make exports competitive against regional players, i.e. Bangladesh, Sri Lanka, Vietnam etc.

Flight of capital

Few months ago, Pakistan economy witnessed an outflow of nearly $25 million plus a day, on occasions $60 million a day, from Pakistan. According to SBP sources, the flight ran into staggering $9 billion a year.

Economic reasons

The SBP also allowed the rupee devaluation few months unchecked which led it to fall as low as 110 against US dollar. Staggering inflation, interest rate drop, government apathy towards main economic problems, political crisis, swollen current account deficits, load shedding, law and order, paints a poor economic condition which led to Rupee depreciation. As a natural consequence rupee was shedding its shine and the depreciation was inevitable. Hence Rupee depreciated against Dollar and lost its ground few months ago.

Why did rupee gain now? What has changed?

How did rupee recover against the dollar? What are some of the reasons which led to the remarkable recovery and made shocking waves in the economic corridors?

According to currency market sources, the rupee was driven by three key reasons apart from many others:

Speculative trading

Coupled with panic from the business community some who had parked their dollars to protect from any wide fluctuation started dumping their dollars causing widespread panic. There were rumors as to who’s who from the government was involved for they want the dollar to drop below Rs100 mark. Even when the dollar was trading at Rs103-04 mark there were widespread news of it dropping well below 99 mark, only to rise back again.

Trip to Gulf did the trick

There is also widespread rumour that the recent trip of the finance minister to the gulf region and some promises made on the diplomatic front regarding the Syrian confrontation also proved fruitful. The grapevine is the Saudis pumped dollar driven credit and deferred oil facility package for the U-turn Pakistan diplomatic front regarding Syrian support. The dollars coming from the gulf visit will go on to improve the foreign reserves. The word goes that finance minister is obsessed with the $11 billion reserves mark and considers it a milestone, once achieved the dollar will see rise yet against rupee. As per some, it will hardly make a dent in the long outstanding economic problems other than the fact that it will temporarily make the reserves look pretty.

Why will this sustain? Will the Rupee hold its current level?

The million dollar question: What is going to come next? The US debt ceiling is not going away coupled with the Ukrainian crisis and dollar index internationally is losing its value. Will the dollar stay below the Rs100 mark against the rupee? Our analysis is based on the following reasons:

Exports & the IMF loan conditionalities

The IMF has been after the SBP, and finance ministry regarding devalued currency, and an export-oriented regime. The Fund will not like to see stronger rupee which hurts the exports and in turn affects government’s ability to pay off the short term IMF installments every quarter. The IMF wants to see a cheaper rupee. Period. And the government would not want to take on the Fund on this issue.

Political pressure

Exporters will start pressurizing the present government through different trade bodies, forums to allow Rupee devalue in comparison with regional trading competitors like Bangladesh, Sri Lanka, Vietnam etc. Needless to highlight that the exporter community generate tax revenue and support budgetary fiscal deficit. Trade bodies like APTMA and Sialkot export bodies and rice export associations, would like a weaker rupee especially compared to regional currencies and a favorable tax refund government policy.

According to sources, many members of the community are at odds with the way finance ministry has been handling their concerns, and may lash out on this issue alone. In short the export community may form a formidable group and have political, social influence over the government – stronger Rupee is going to go down well.

Regional currencies & trading partners: Case for devaluation

Needless to get into technicalities, but simply, cheaper rupee makes economic sense. It is not possible for exports to grow, amidst a strong currency and regional trading partners. In pure economic terms, rupee may not be able to hold its current values and may soon undergo devaluation.

Conclusion

It will not hold for long and rupee may lose ground to dollar.

Word of Caution

The legend of rupee will last as long as it is stable. If the government plans to carry such short term measure to make it look good, it may soon find it will do so at the expense of losing credibility of the rupee.

Whatever the future holds, rupee holds its current levels or dollar loses, it is not interest of the government to make rupee drop and rise like a yoyo and that too at such a pace as it did recently. It will soon realize that its credibility will be hurt the most and with it government may also expose the currency to ruthless speculator groups which will ruin its stability and ability to stand for something strong and solid.

Some feel that instead of opting for devaluation, is it a good time to check current account deficit, Tax to GDP ratio, budget deficit, government expenditure and encourage public private partnership models and so on.