Pakistan’s Rupee Devaluation of Little or No Avail

Pakistan’s fiscal and monetary conditions have only worsened in the past few years leading to the devaluation of the currency by as much as 15% YTD (2018).

Let’s look at a few charts that matter:

When a country devalues its currency their goal is to spur export growth by making their goods & services cheaper and curtail high imports.

However, in case of Pakistan, the imports have remained elevated and exports have slowed down considerably even in the event of devaluation.

Post devaluing the PKR 3 times this year (2018), the imports have remained stubborn at 676 PKR billion whereas exports plunged from around 250 odd PKR billion to 224 PKR billion, down to pre-devaluation levels.

As a result, the country’s CAD or Current Account Deficit has deteriorated to unhealthy levels, the lowest since 2010.

Maybe we owe this divergence in import-export to the so called Michael-Lerner Equation & the J curve effect?

The concept states that currency devaluation’s initial impact is a worsened BOP as there’s usually a lag between the pickup in exports (drop in imports) and devaluation.

The economy takes some time in order to structurally shift and realize that the imports are now expensive (so reduce them) and the exports are cheaper (so importing countries find it attractive and import more).

Whether Pakistan’s exports are still competitive considering its peers is another question.

Now the natural impact of this is on the FX reserves, which have dropped sharply amid rising oil imports, lower FDI, higher debt burden, rising US interest rates and the list goes on. (with the China CPEC also putting a strain on the country’s BOP)

Here’s a chart by Bloomberg:

Although, the condition is not as worse as in Argentina, Turkey and the like where the outflows have been much higher, this is also worth noting.

Here you can observe that the FX reserves have been declining consistently and have almost halved from their 2015 peak of around $24 billion to around $15.9 billion currently, reducing their import cover.

Pakistan’s real reserves have dropped below the level reached when the country approached IMF the last two times for a bailout, according to Bilal Khan, a senior economist at Standard Chartered Bank Plc. With elections scheduled for July 25, the next government will need to approach the IMF as a “matter of urgency,” said Khan. (Source: Bloomberg) This has thus, lead the State Bank of Pakistan (SBP) to hike rates by almost 100bps (175bps YTD).

Will this able to reverse the flows, reduce CAD (Current Account Deficit) and stabilize the economy with the backdrop of vanishing dollar liquidity and tightening monetary conditions across the globe? Maybe not.

Will we look at an International Monetary Fund (IMF) bailout? IMF is largely influenced by the US and with the on-going tensions between Washington and Beijing; an IMF bailout will be a less likely option for Islamabad.

President Trump probably believes that it would not be in the interest of US tax payers (whose money is being used to fund the IMF) to bailout the Chinese bond holders who have lent money to Pakistan for their ambitious BRI (Belt & Road Initiative) and CPEC (China Pakistan Economic Corridor) projects.

Harsh Shivlani
Team Leader– Fixed Income & Derivatives
(M.Sc. Finance, NMIMS – Mumbai. Batch 2018-20)

Connect with Harsh on LinkedIn

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