No quick fixes

To our economic sorrows, in particular an artificially strong rupee, falling exports and remittances

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The rupee declined sharply against the US dollar during intraday trading on July 5 and neither the central bank nor the federal finance ministry has until now offered no rationale or clarification – other than the former finance minister, as is his wont, frothing at the mouth while giving vent to his spleen with cameras rolling. Ah, and a head was made to roll, with the acting governor biting the dust, replaced by a crony of a recently-retired bureaucrat for the all-important tenured position.

This notwithstanding nothing to explain the steep and abrupt fall, by as much as 3.2% in a matter of hours, with  the rupee falling by around 3.2% against the US dollar in interbank trading from 104.85 [a level that has by and large been sustained for more than two years] to 108.50.

In a decent, self-respecting nation the (now former) finance minister would have sacked himself, but unfortunately what is norm elsewhere is not the done thing in our neck of the woods. Well, the Supreme Court took care of that by directing NAB to issue a reference against him on Friday in the Pananma Papers Case against the Sharif’s.

Instead, our now-former federal finance minister Ishaq Dar called a meeting of head honchos of banks in the public and private sector to arrest the steep decline and retrieve the rupee to its pre-fall status.

Having worked in a treasury of one of the largest private sector banks, this scribe has personally dealt the rupee in volatile conditions. On September 26, 2013, for example, almost an identical fall was witnessed.

The resemblance is uncanny. Quite like July 5, ’17, on 9/26 the interbank market opened and trading commenced at a mundane, tepid pace. Within hours the landscape had changed diametrically, with the rupee hurtling into a sudden nosedive. By the end of the ‘Ready Session’ (same day settlement), it had depreciated from 107.50 (the opening rate) to around 111.50 for a greenback – the highest quoted rate in the market on that day.

Quite curiously, in the second session the same day, a major correction was witnessed and the rupee appreciated as rapidly as it had gone down to settle at 105.50. Panic and uncertainty reigned in the market, and as is the custom in such cases, the central bank called up treasuries of all banks, ordering them to immediately halt all trading, L/C retirements and subsequently trading in the prescribed range.

On the morrow, two teams, one apiece from State Bank of Pakistan (SBP) and Federal Investigation Authority (FIA), swooped on treasuries of all banks, public and private, to collect and examine the front and back office data of trades and deals from that fateful day.

That particular sudden volatility was, as the explanation summarised, was sparked by multiple major payments (including a quite substantive one for an oil import L/C and another for a due IMF repayment) falling on the same day. Mishandling and criminal negligence by the regulator – the central bank – had only exacerbated the situation!

The latest case in point was much different and, to a trained eye, the rupee’s slide seemed to be all the more intentional than it seemed. The level of Rs104.50 has been maintained, much to the consternation and ire of exporters, for more than two years now.

It has remained Ishaq Dar’s ‘comfort zone’, for to him, it augments the feel of the country’s economic health, making it look rosier than it is.

A source in the finance ministry divulged on conditions of anonymity, since Dar runs the central bank like his personal fief, trampling over its independence at will, letting the rupee slide and desisting intervention when it was happening was the SBP’s riposte to the ex-federal minister to go take a hike.

Having said that, realistically it is not possible for such a major fall in the rupee’s value to come about without his blessing.

In order to keep the rupee/dollar parity range bound, Dar’s suggestions, actually diktats, verbal of course, dictate the course the central bank takes to intervene in the market through banks to manage the demand and supply of US dollar.

But the rub is that the kind of economic reform that adds value to exports and increases foreign exchange earning has not been pursued in the present electoral cycle – nor in the previous one, for that matter. Hence the current account black hole that has rendered the strong rupee useless. Having one of the strongest currencies in the region (vis-a-vis the dollar, of course) might make Dar sleep better, but it’s not doing the economy any favours.

There was also the narrative that the then prevalent political instability and uncertainty, which wouldn’t cease unless this whole Panama issue, with PM’s impending dismissal a possibility was resolved.

This is pure hogwash.

Here is why and how of it. The demand and supply of dollars in the market is hardly influenced by what is happening in the political arena. A source from the central bank, speaking on condition of anonymity, said that the recent fall was not a surprise and all relevant authorities (Read: Mr Dar) had signed on the calculated move to refrain from any market intervention and let the rupee slide.

According to SBP’s statement the day after the event, the rate will be maintained between Rs105 and Rs107 against the US dollar. At the time Dar said there will be a ‘comprehensive inquiry’ but that is an eyewash, a mere statement. The official line taken by the SBP is that this move was months in the making and had to be done to balance the external account. The finance ministry, however, calls the decline ‘artificial’ that has negatively affected foreign exchange markets.

This public spat was bound to happen. Contrary to the IMF’s recommendations, no move has been made by the government to give independence to the central bank, where the finance ministry has absolute control since the PML-N came to power. In the past, crucial monetary policy announcements, like changes in the discount rate, for example, have been made by Ishaq Dar, not just much in advance of but instead of the SBP governor – something unheard of elsewhere in the world, for it impinges on the autonomy of the regulator.

Other than that, this particular incident brought into sharp relief two worrying aspects. One, that the rupee is overvalued and the real effective exchange rate (REER) is actually around Rs120, a concern that has been conveyed by the IMF innumerable times to the Finance Ministry, only to be disregarded by him. Two, the country’s economy is being run so shambolically that something as serious an issue as the value of the rupee is dealt with in a manner so bizarrely nonchalant – to gain political mileage with sleight of hand.

In keeping with the incumbent government’s general tendency on most substantive issues, all critical decisions pertaining to but not limited to the economy are being made excluding the cabinet or state functionaries, with next to no transparency, either by the family in Jatti Umra or the kitchen cabinet. The exchange rate must be quite low on the priority list to warrant serious debate and discussion, that too among people whose technical knowledge about it is at best sketchy.

Dar doesn’t like seeing a weak rupee and has adopted the unsustainable model of intervening in the foreign exchange (FX) market with borrowed dollars (our FX Reserves). As the accumulated pressure mounts, or when someone makes a miscalculation (2013), or a decision is taken at the top to not intervene altogether (July), something is going to snap, and it can’t be anything other than the rupee taking the plunge.

The kind of depreciation in the exchange rate might not impact the ex-prime minister’s shopping binges in the swank stores on Bond Street on his too-frequent London vacations, but is surely a serious blow to small traders and importers who regularly open L/Cs and make budgets that allow only for reasonable movement in the exchange rate. Their hearts must have skipped a beat or three when the dollar went up Rs3.5 a pop in a few hours.

Looking at the current macroeconomic indicators another dip in the rupee’s value seems highly likely – though it maybe not as severe and as abrupt. A host of seasoned bankers and it includes savvy treasury managers are found to be endorsing this sentiment.

At a whopping $12.1 billion Pakistan’s current account deficit is now double what it was last fiscal year which translates into 4% of GDP. Though the increase was forewarned owing to CPEC-spawned imports from China and elsewhere, the extent was supposed to be this deep. The reported figure definitely is far more frightening.

Our two major sources of foreign exchange to offset the deficit number are expatriate remittances and exports. Remittances fell by 3.1% to $19.3 billion in fiscal 2017 (FY17) and exports were down 3.13% for the past eleven months; the glitch is that in both cases there are no quick fixes.

No method, pure madness

At the top of it, this propensity to borrow and worry about it later definitely has no method to it, it’s just pure madness. Borrowing at usurious interest can only be dubbed that.

No wonder our external debt at $58 billion is at its highest ever, and a significant portion of it has employed only to boost up our foreign reserves so that our former finance minister could feel cosy. These reserves are then used to pay back other long term loans and also control the rupee dollar parity.

All loans have repayment deadlines. A significant number of foreign loans reached maturity in the last six to seven months. No wonder foreign reserves held by the SBP dwindled by 15%, falling from $18.28 billion at end-December 2016 to $15.5 billion in mid-July 2017, despite injection from here and there.

“You can hardly call this a strategy let alone a sustainable one. You’re borrowing at undisclosed interest rates to replenish foreign reserves that are already mostly made up of loans. It was a matter of time when the rupee fell the way it did and it is bound to happen again minus some significant reforms in our FX policy”, commented a leading bank’s treasury sales desk dealer.

Inevitable, a weaker rupee

A common perception about the relationship between the SBP and finance ministry is that the former can do very little without the latter’s approval. After speaking to treasury professionals at various local banks it seems that is slowly but surely changing, at least when it comes to the rupee.

Most bankers now think that a weaker rupee is inevitable and the SBP wants to let it slide in a controlled way, unlike the July 5 episode that saw huge intraday movement.

“It was an unsustainable model, to begin with, and, quite frankly, I am surprised it has lasted for two years with such a stable rate. Better sense has hopefully prevailed but only time will tell how independent the SBP really becomes of the finance ministry to let the rupee settle close to its actual value,” explained a senior banker.

Inherited mess?

True economic reform takes time and more than that the will to see it through. It therefore doesn’t take a genius to see the issue at hand. The policies that are required to get a hold of this macroeconomic mess can take longer than the five-year term limit of a government in Pakistan. So what is easier to do is label the economy’s condition an “inherited mess” for the first half of the tenure while doing very little to fix it.

Then comes the latter part where you have to deliver. By then the stop gap arrangements will have made the hole so big and deep that it is difficult to climb out of. Add to that the risk of by some miracle fixing the mess and not coming in for another 5 years – the credit is taken by the next party in power.

This selfishness accompanied by placing incompetent cronies in top financial policy making positions is the real malaise.

*All the treasury professionals, both senior and junior, were unwilling to utter anything on record owing to restrictions by corporate communication departments of all banks.