Finance: What after rupee fall? – Newspaper
Foreign exchange reserves at the State Bank of Pakistan (SBP) dipped to $3.678 billion on January 20 from $4.601 billion. USD due to repayment of external debt. At this level, the reserves provide an import cover of three weeks against a standard minimum of three months.
The SBP reported a new level of foreign exchange reserves on January 26 and at the same time removed the cap on the official exchange rate. As a result, the rupee fell Rs255.43 to a US dollar in the interbank market from 230.89 a day earlier. On January 27, the central bank allowed the rupee to fall further – this time to 262.6 to the dollar.
This unprecedented 13.7 per cent. rupee depreciation within two days, which was undertaken to meet a key condition for the resumption of a frozen International Monetary Fund (IMF) loan, is expected to bridge the gap between the interbank and open market exchange rates.
The expected increase in remittances and export dollars will ease the pressure on foreign exchange reserves, more so because the increase in the value of the dollar will help limit imports. This comes at a time when the SBP has promised to start easing restrictions on import payments as 5,700 containers of imported food, medicine and industrial raw materials are still waiting to be cleared at Karachi Port.
Most of the lending to NBFIs will take several quarters to be channeled to productive sectors
From February-March, the country expects significant inflows of dollars from the IMF and other international financial institutions, as well as from three friendly countries – Saudi Arabia, the UAE and China. It will be a supplement to the relief packages that the world has promised after the flood.
Some of these packages are short-term and can be expected to start arriving in February-March. But external debt payments due before the end of this fiscal year on June 30, 2023 are huge at about $8 billion. This means that the bulk of foreign exchange funds expected to come in (after the resumption of the IMF loan program) will be consumed by external debt servicing.
That’s because despite all restrictions on imports (despite falling GDP), the overall trade deficit is expected to remain large enough to eat up remittances.
The phenomenal depreciation of 13.7 per cent. rupee follows a one percentage point hike in the central bank’s key interest rate announced on 23 January. The interest rate increase – from 16 per cent. to 17 per cent. – was intended to limit inflationary pressures. But the massive depreciation of the rupee is bound to trigger a new – and most likely stronger – wave of price hikes. After making the exchange rate market-driven, the government will also raise the development levy on fuel and increase electricity and gas tariffs to meet the other two key conditions of the IMF loan. It will add further fuel to inflation and make monetary tightening ineffective against inflationary pressures.
The only objective the higher interest rate will serve is to dampen further aggregate demand, which is otherwise declining after last year’s super floods, political chaos at home and amid a global economic slowdown. Industrial units are closing or reducing operations and people are losing daily jobs.
An indicator of declining economic activity in the country is that the private sector’s borrowing this year is still too small. (The economy is set to grow just 2 per cent this financial year, down from 6 per cent last year). Moreover, massive public borrowing from banks (Rs 1,307 trillion in seven and a half months of FY23) is not being channeled into productive sectors. Almost the entire loan amount is used to finance the fiscal deficit.
But banks’ net lending to non-banking financial institutions (NBFIs) remains unusually strong. In about seven and a half months of this fiscal year (between July 1, 2022 and January 13, 2023), banks lent 213 billion. Rs to NBFIs against only about Rs 3.7 billion. Rs. in the period of the previous year, according to SBP.
The term NBFIs covers investment associations, pension funds, asset management companies, real estate investment associations, investment banks, leasing companies, Modarabas, non-bank microfinance companies and housing finance companies, etc.
On the other hand, the entire private sector (minus NBFIs) got Rs410 billion. bank credit for seven and a half months of this financial year – significantly down from Rs787bn. in the period of the previous year.
The phenomenal growth in bank lending to NBFIs indicates the intensity of financialization of the economy in the absence of the desired real sector growth. Most of the banks’ lending to NBFIs will continue to circulate within the financial sector – changing hands many times – and will take several quarters to be channeled into the productive domestic industry.
Published in Dawn, The Business and Finance Weekly, 30 January 2023