REER moves towards fair value

Recovery in real effective exchange rate was due following depreciation

KARACHI:

Pakistan’s real effective exchange rate (REER) - the value of country’s currency against a basket of currencies of global trading partners -appreciated towards its fair value in November 2021 compared with October 2021.

“REER index was recorded at 98.5 in November 2021 compared to 96.4 in October 2021,” the State Bank of Pakistan (SBP) reported on its official Twitter handle on Saturday.

“REER index is considered to be at fair value when it is around 100,” Arif Habib Limited (AHL) economist Sana Tawfik said while talking to The Express Tribune.

A REER reading below 100 is supportive for countries like Pakistan whose trade and current account deficits have widened to challenging levels and are causing a reduction in the country’s foreign exchange reserves.

She elaborated that a slightly depreciated REER would help in reducing the cost of exports, which was the need of the hour. On the other hand, the depreciated REER makes imports expensive.

Earlier, the government took a number of measures to increase exports and slash imports in a bid to overcome the widening current account deficit and balance of international payments, she said.

However, “REER had depreciated more than required and a recovery was due.”

Following the recovery in REER (in November), Pakistan’s exports remained competitive but imports turned expensive because the reading stood below 100, Tawfik said.

Contrary to the recovery in REER in November, the Pakistani rupee depreciated persistently against the US dollar.

“Appreciation (depreciation) of REER is sometimes confused with the concept of currency overvaluation (undervaluation), however, these are two separate concepts and cannot necessarily be interpreted in the same direction,” Pakistan’s central bank said while explaining REER on its website.

The rupee closed at Rs175.72 against the US dollar on November 30, 2021 compared to Rs171.2 on October 29, 2021, according to the central bank data.

In addition to the currency value, the factors that are taken into account for calculating the REER value include inflation reading in the country and its trading partners and the value of goods of two trading partners in a third country.

To recall, the inflation rose to a 21-month high of 11.5% in November owing to a spike in prices of global commodities that are imported to meet domestic demand.

“Currently, the State Bank of Pakistan is using (currencies) weight of 37 major trading partners and competitors of Pakistan for REER calculation,” implied a central bank’s video explaining the concept, construction and interpretation.

“These weights represent not only the bilateral trade volumes but also the competition in third markets,” it said.

“For example, the weight of China in the index is 29.12%; it not only represents the trade volume between Pakistan and China but also the competition between Pakistani and Chinese firms in a third market like the US.”

Experts said that the rupee was expected to stabilise at around Rs175-76 against the US dollar ahead of the resumption of International Monetary Fund’s (IMF) $6 billion loan programme by the end of January or early February 2022.

The resumption of the programme by the IMF board will be followed by the release of next loan tranche of around $1 billion. This will also open other avenues for foreign currency inflows like from the World Bank and the Asian Development Bank (ADB).

In addition to this, the expected reduction in the current account deficit to below $1 billion a month in coming months compared to the 40-month high of $1.9 billion in November would help to stabilise the rupee and keep REER at its fair value, she said.

“We (AHL) anticipate that the rupee will hover around Rs178 against the US dollar by the end of current fiscal year (on June 30, 2022) … and around Rs180 by the end of December 2022,” she said.

Published in The Express Tribune, January 16^th, 2022.

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