ISLAMABAD: The International Monetary Fund (IMF) has asked Pakistan to let market forces decide the fate of the rupee and go for a total free-float of the exchange rate, which the finance ministry is reluctant to accept due to its adverse implications for the economy.
Instead of accepting the condition of allowing market forces decide the value of the rupee, the Pakistani authorities are willing to further weaken the currency, said officials in the Ministry of Finance and the State Bank of Pakistan (SBP).
The IMF was taking an extreme position on the exchange rate due to the almost fixed value of the currency when Ishaq Dar was leading the finance ministry.
The officials said the total free-float of the exchange rate was not acceptable to Pakistan but the finance ministry was willing to let the currency depreciate that may largely reflect market fundamentals.
Policy talks with the IMF for the bailout package have reached a critical stage where both the sides are now penning down the conditions. These conditions have to be met before the approval of the loan by the IMF board and during the programme implementation period.
There is also difference of opinion on the extent of further currency devaluation by June 2019, according to the sources. The IMF is asking for a massive devaluation, which if accepted could push the rupee far above Rs150 to a dollar in coming months, they added.
The rupee traded at 133.89 to a dollar in the inter-bank market on Friday. Since December last year, Pakistan has let its currency weaken by 26.6%. Still, the IMF experts believe it is not enough, they added.
Since January, Pakistan has increased interest rate by 275 basis points to 8.5%, which is the highest increase by any Asian country.
Finance Minister Asad Umar has also reached out to independent economists and members of the Economic Advisory Council to get their views on the total free-float of the exchange rate as demanded by the IMF, said the sources.
These experts have also opposed the IMF demand, urging the government to continue with the ‘managed market-based exchange rate regime’ but more aligned to the economic fundamentals, according to the sources.
They argued that the total free-float will be disastrous for Pakistan. They were of the view that a total free-float would not work due to the very thin size of Pakistan’s currency market, apprehending that the few dealers would exploit the government.
The currency depreciation also carries serious implications for the inflation rate, which is already on the rise, touching a four-year high.
Pakistan implemented a fixed exchange rate system from 1947 to 1982. Then a managed floating exchange rate system was adopted in January 1982.
Since 2000, the country is theoretically following a market-based exchange rate but the SBP has been pumping billions of dollars annually to keep the rate at a level desired by the Q-block.
The IMF is also demanding more autonomy for the central bank, said the sources. Finance Minister Umar is willing to give full autonomy to the SBP for determining the value of the currency.
Pakistan’s foreign exchange reserves dipped to $7.4 billion last week. The reserves have also been used during the Pakistan Muslim League-Nawaz (PML-N) government’s tenure to defend the value of the rupee.
Pakistan’s external-sector vulnerabilities would not be fully addressed by the exchange rate tool alone and the government will have to apply a combination of interest rates hike, currency depreciation and administrative measures to contain aggregate demand in the economy.
Economic theories suggest that the currency devaluation could boost exports in a big way but Pakistani exporters heavily rely on imported raw material. One dollar worth of exports requires 35 cents for imported raw material, according to independent experts.
Secondly, the historical evidence suggests that 10% depreciation of the currency curtails the import bill by only 3%.
During a recent Business Advisory Council meeting, the country’s leading industrialists suggested to the prime minister that there should not be more devaluation and interest rates hikes – the demands that the government cannot meet due to upcoming monetary policy adjustments.
Published in The Express Tribune, November 17th, 2018.