REER hits 18-month high

Appreciation in real effective exchange rate may widen current account deficit


Salman Siddiqui December 01, 2022
PHOTO: FILE

KARACHI:

Pakistan’s real effective exchange rate (REER) – the value of domestic currency against the basket of currencies of trading partner countries – hit an 18-month high at 100.4 on the index at the end of October 2022.

The REER appreciated by almost 10 points in a single month in October 2022 compared to 90.71 in the prior month of September 2022, according to State Bank of Pakistan’s (SBP) data on Wednesday.

A REER value of below 100 is helpful for emerging economies like Pakistan, whose imports remain significantly higher (almost three-fold), as compared to their export earnings. Similarly, a REER value above 100 is considered a negative development for such economies as they bridge their deficits via the accumulation of foreign debt.

Over the past 18 months, the central bank had maintained the REER mostly in the range of 96-97 on the index. Experts termed this as a fair level, which was supportive towards narrowing trade and current account deficits.

A REER appreciating suggests that the country’s exports have shrunk and imports have become cheaper during October. This stands as a negative development. Accordingly, it may lead towards widening the country’s current account deficit (CAD) and offsetting the government’s own measures to narrow down the CAD.

To recall, the domestic currency appreciated by 3.31% (or Rs7.57) in one month to reach Rs220.88 against the US dollar on October 31, 2022, as compared to Rs228.45 on September 30, 2022. The rupee closed at Rs223.95 on Wednesday (November 30, 2022), as compared to Rs220.88 on October 31, 2022, suggesting that the value of the REER would have also decreased slightly in the month.

Pak-Kuwait Investment Company (PKIC) Head of Research, Samiullah Tariq explained that “The high inflation reading at over 26% in October in Pakistan, as compared to the global average of 6-7%, also caused the REER to appreciate to 100 in the month.”

Tariq, however, termed “REER at 100 as fair value,” adding that it would be- come overvalued if it appreciates over the level of 100.

“The REER hit levels

between 125-130 during Finance Minister Ishaq Dar’s previous tenure, 2013-2018. It has moved up again to the level of 100, considering that Dar believes that the fair value of the currency lies in the range of Rs180-200 against the greenback.”

A gradual appreciation in the currency’s value has also diverted remittance inflow from formal banking channels to informal and illegal channels, including the hawala-hundi black market. Accordingly, remittances sent home by overseas Pakistanis hit an eight-month low of below $2.5 billion in the month of October, he recalled.

According to the Pakistan Bureau of Statistics (PBS), the country’s imports reduced by around 12% to $4.71 billion in October, as compared to $5.35 billion in the prior month of September.

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