SBP pumped $1.2 billion to defend rupee: WB

Says move comes after 8.1% depreciation against the dollar since June

ISLAMABAD:

A new World Bank report has confirmed that the State Bank of Pakistan pumped $1.2 billion to defend a weakening rupee and also underlined that the government’s decision to impose regulatory duties would not solve the current account deficit problem.

The Pakistan Development Update – the flagship biannual report – released on Thursday, also shed light on the reason behind why Pakistan’s exports were not increasing despite massive currency depreciation.

“The rupee has already depreciated by 8.1% against the dollar since end-June 2021, and between mid-June to early September, the central bank used $1.2 billion in reserves in an attempt to mitigate disorderly exchange rate adjustments,” according to the WB report.

On September 15, The Express Tribune had reported that the central bank threw $1.2 billion to defend the rupee, which was also contrary to the stated policies of the central bank, International Monetary Fund (IMF) and finance ministry, as all the three institutions claim that the rupee value is determined by market forces.

Read: State Bank of Pakistan reserves hit all-time high of $20.15b

The central bank reserves are built by taking expensive foreign loans like floating the Eurobond and issuing the expensive Naya Pakistan Certificates. The $1.2 billion injection was equal to $1.2 billion annual oil facility that Pakistan secured from Saudi Arabia this week.

Sources told The Express Tribune that the central bank continued pumping dollars in the market in the remainder period of September to first half of October and the quantum of intervention was double than in any single month.

The WB said that given that external public debt is a third of the total public debt stock, the depreciation of the rupee has also implications for public debt, which is already at 90.7% of the gross domestic product. It added that Pakistan remained vulnerable to public debt related shocks.

The WB attributed the rupee depreciation to widening trade deficit, downgrading Pakistan’s stock market by MSCI, increasing likelihood of global monetary tightening and the Afghan crisis.

The report discussed in detail Pakistan’s current account deficit problem, which it said was stemming from low exports rather than from higher import bill.

Due to strengthened domestic demand, imports have grown much higher than exports in recent months, leading to a large trade deficit, the WB said.

The key factors that are hindering exports are high effective import tariff rates, limited availability of long-term financing for firms to expand export capacity, inadequate provision of market intelligence services for exporters, and low productivity of Pakistani firms, the WB said.

The increasing use of regulatory duties is not going to be an effective tool to contain the trade deficit due to limited share of non-essential goods of hardly 9% to 10% in the import basket, Gonzalo Varela, the senior economist in the macroeconomics, trade and investment global practice of the WB, said. He said that 80% of the exports are of productive purposes.

By imposing regulatory duties, the imports cannot be fixed but the revenues would surely increase, Varela said. The increase in exports relative to the rupee depreciation is slow due to inflation and low demand from trading partners, he added.

In long term, 1% depreciation of the inflation-adjusted exchange rate should increase exports by half percentage points, the trade economist said. The regulatory duties have become much prevalent in recent years and as a result the average import tariffs in Pakistan have gone up to 20%, Varela said.

The WB has projected the current account deficit to widen to 1.9% of the GDP in this fiscal year. The deficit was almost three times more than the last fiscal year in terms of size of the economy.

The current account deficit will taper down due to the impact of the exchange rate, Zehra Aslam, the WB economist, said.

The WB said that a key factor driving the trade imbalance is the declining export competitiveness. The share of exports in GDP has been declining since the turn of the century, from 16% in 1999 to 10% in 2020. This falling export share has implications for foreign exchange, jobs, and productivity growth.

The main causes of the falling exports are high effective import tariff rates and limited export market access that tend to discourage exports. Second, the supporting services for exporters are inadequate, especially those for long-term financing of capacity expansions and market intelligence services to secure new export contracts. Third, the low productivity of Pakistani firms hinders them from successfully competing in global markets, according to the WB.

The report underlined that the SBP’s decision to add 114 items to the list of import products that require 100% cash margins would also be ineffective. This will increase firms’ financial costs and acts as a non-tariff barrier to imports, the WB said.

Pakistan’s import bill is not particularly large when benchmarked against comparator countries, nor is its composition tilted towards luxury or even consumer goods.

As a percentage of the GDP, imports of goods and services stood at 17% in 2020, below Bangladesh’s 19%, Egypt’s 21%, or Vietnam’s 103%, all Pakistan’s peers in the size of economy. In terms of composition, Pakistan’s merchandise imports are mainly for industrial or commercial use.

The WB said that these items are already facing very high import duties and further increases will not curb their consumption substantially, as demand is relatively inelastic. Third, the import content of domestically produced substitutes is high, and therefore any substitution away from imported and into domestic luxury goods will likely lead to an increase in imports of parts and components to produce the domestic versions.

“Thus, instead of achieving the intended goal, these measures exacerbate the already pronounced anti-export bias of Pakistan’s trade policy and add uncertainty by increasing the likelihood of sudden policy changes that affect firms’ cost structures,” according to the WB.

But the WB said that with limited external buffers and elevated financing needs, the rapidly growing imports and wider trade deficit have heightened external risks and resulted in pressures on the exchange rate and consequently reserves.

The long-term decline in exports as a share of the GDP has implications for the country’s foreign exchange, jobs, and productivity growth. Therefore, confronting core challenges that are necessary for Pakistan to compete in global markets is an imperative for sustainable growth,” Derek Chen, the senior economist of the WB, said.

The WB has recommended gradually reducing effective rates of protection through a long-term tariff rationalisation strategy to encourage exports, reallocate export financing away from working capital and into capacity expansion through the Long-Term Financing Facility.