Hussain Haider |
Mr. Hussain Haider, Head of Research at JS Global Capital, explains to GVS the financial challenges caused by external debts, loan repayments, trade deficit, and foreign exchange fluctuations. The financial expert highlights the outcomes of policies of the past and sheds light on the IMF-deal and a market-based exchange rate.
Pakistan has been combating financial challenges ever since it came into existence in 1947. Marked with political upheavals and corruption, Pakistan’s dependence on foreign loans and grants was always endorsed but never justified.
Currently, the country is faced with a sharp trade deficit and foreign loan repayments that are crippling the economy because of corruption and lack of astute policymaking. Global Village Space reached out to Hussain Haider, equities specialist and economist at JS Global, to explain the foreign exchange fluctuations, trade deficit and other financial challenges faced by Pakistan.
Pakistan's foreign reserves held by the State Bank of Pakistan as of June 21 were $7.2821 billion – During the week ending June 21, 2019, SBP’s reserves decreased by $322 million due to external debt servicing and other official payments
— omar r quraishi (@omar_quraishi) June 27, 2019
Haider noted, “As we review the movement of our exchange rate over the past 10-20 years, we note that the most important role is that of our external borrowings, i.e. the foreign debts that we take from different sources, multilateral agencies, bilateral assistance, foreign banks etc.”
PMLN: Non-essential Imports & Foreign Debt
The State Bank always creates a buffer to support the currency, a strategy that was too obvious during the previous government’s tenure. We often hear that the Ishaq Dar-led financial team maintained the exchange rate at an overvalued rate, and whatever foreign loans they were taking, they had the buffer that allowed them to maintain the exchange rate in a certain band, say 95-105.
Haider said, “Despite that cushion, the country reached a point where further external borrowing became difficult to obtain, and as time was passing by, Pakistan did not have much borrowing capacity.”
Haider explained that during this period, the trade deficit became increasingly uncontrollable, with the blame squarely placed on CPEC-related machinery imports. Granted, while machinery imports did increase, there was also a sharp rise in the imports of non-oil and non-machinery imports, luxury, automobiles and non-essential goods.
The current bearish spell of the rupee has emerged as the sharpest trend in the last thirty years. This devaluation cycle has been going on for 19 months
The equities specialist noted, “Pakistani malls, shopping centers and even grocery stores are filled with imported products, and this obsession with imported products is ruining the economy. When you are running a trade deficit, it simply means that you need dollars.”
“On the one side, our trade deficit was increasing substantially, and on the other side, our external borrowing capacity was getting completely choked up. As these forces combined, accompanied by a government change after the general elections, they caused the economic situation to deteriorate even further.”
Haider noted that despite the fact that oil prices have been comparatively lower than during the 2008 crisis, our economic situation has deteriorated alarmingly.
The basic understanding behind debt is that it needs to be repaid. Pakistan is facing repayments on a monthly basis, which requires dollars. If the IMF loan gets approved soon, this will allow some money to be funneled into the economy.
He said, “The current bearish spell of the rupee has emerged as the sharpest trend in the last thirty years. This devaluation cycle has been going on for 19 months now, and the rupee has lost around 35%. Such an alarming devaluation has never occurred in the past. On average, I recall that the bearish spell usually lasted for around 12 months in the past three decades, and the average rupee devaluation has been 15-19% in one go.”
Dollar to Rise Further?
In a recent press conference in Karachi, the Governor of the State Bank informed that Pakistan has now entered a market-based regime, and the managed float regime has been discarded, which has drawn strong criticism that if you are leaving everything on the dynamics of the market, what is the purpose of the State Bank and its competent team of financial experts?
Haider noted, “This was not an option for the Government of Pakistan, and it is important to understand that we no longer have the luxury to manage the exchange rate, which requires you to have some dollars in your pocket, and whenever you see pressure building up in the FX market, you increase the supply of dollars by simply swapping rupees with the dollars. This allows countries to manage their exchange rate by increasing the supply of dollars in the market.”
The economist explained that this situation is no longer an option since Pakistan is facing a shortage of dollars, leaving no choice but to adopt a market-based regime.
He observed, “This is not a decision which was taken by the central bank. The truth is that there was no other option left given a sharp drawdown in FX reserves! This has created an impression of local currency in free-fall. However, what is also important to note is that when the system will have a dollar inflow, you will witness the rupee appreciating from whatever levels it has depreciated to.”
He explained that dollars are leaving the system due to surging import bills or debt repayments; it creates pressure on the currency’s valuation. In the short term, this can only be managed by exploring external funding sources, which is what the government is already working on. Moreover, global lending institutions usually require a stamp of approval from an accredited source such as the IMF.
For instance, the total funding arrangements from Saudi Arabia so far is north of $7 billion, including the already deposited $3 billion, and upcoming deferred oil payments starting from 1st July, amounting to approximately $4.4 billion per annum. However, Haider noted that this will not usher in any relief for the public.
IMF Diagnosis: Manipulative or Favorable?
Commenting on the rhetoric of IMF’s manipulative policies and strategies, Haider noted, “This is simply filler talk that we hear on media, speculations about political rivalries, hostilities with US and so on.”
Haider highlighted, “Pakistan is a chronic user of the IMF funding, marking Pakistan’s 22nd bailout package from the IMF.”
The economist noted that it would be wrong to deduce that the IMF controls the conditions and manipulates requirements, in fact, that are no Pakistan-specific conditions. He said, “Those claiming that the IMF will push Pakistan into a financial ditch should realize that our fiscal condition already has us on the edge.”
Is the IMF package designed to support an atmosphere for political unrest in Pakistan against the Imran Khan government? Is the Egyptian script used against President Morsi being used against Imran Khan now? https://t.co/2Dg7ahhNZa via @@GVS_News
— Moeed Pirzada (@MoeedNj) May 18, 2019
Haider concluded that the IMF has put forward a diagnosis that encourages Pakistan to raise taxes and generate revenues. Note that all these tough measures for which the government is being vilified would undoubtedly have to be taken in any case, with or without the IMF.
Market Based-Exchange Rate
Haider noted that a market-based regime is the only option left.
He explained, “The FX reserves have been depleting, leaving no choice but to rely on a market-based exchange rate, which is generally more volatile (in both directions). This volatility will soon become the new normal.”
There were again news of debt repayments this past week, and this outflow of dollars has created a lot of pressure on the rupee, triggering its rise to 165. Haider noted, “July is an important month, and if we get approval, it will allow $500-600 million to enter the system from IMF’s first tranche. Additionally, we need to track developments on FATF, specifically their upcoming decision later this year.
The financial expert noted that the situation can improve if the Asian Development Bank or the World Bank agrees to help. If we receive, say $1-2 billion from here, coupled with any additional bilateral support, we might see the rupee appreciating to under 150 level against the dollar.
Pakistan is a chronic user of the IMF funding, marking Pakistan’s 22nd bailout package from the IMF
Haider added, “this may create a feel-good factor, pushing people into a false sense of security that the market has improved, possibly leading to a positive reaction from the stock market as well. However, given the debt repayments looming ahead, with the passage of time, this situation could reoccur and towards the later part of this calendar year, the dollar may rise up to 165-170.”
Debt Rescheduling: A Possibility?
Haider highlighted that the most important and widely anticipated news is that of debt rescheduling, allowing Pakistan some flexibility in terms of deadlines and relief. He remarked, “This will assist the Rupee to stabilize, but in the absence of such news, Pakistan will be in dire need of excessive external borrowing, compelling us to issue more bonds and reach out to external sources. The FATF decision could be another significant influencer on Pakistan’s already formidable economic challenges.
Another crucial indicator that needs to be closely tracked is the mounting fiscal deficit. This is because the heightened budgetary financing requirements will eventually take a toll on the exchange rate.
“The situation can be managed primarily by debt rescheduling if the lenders decide to create more flexible yearly schedules for Pakistan. In the absence of any debt rescheduling offer, the exchange rate is likely to go haywire, and I wouldn’t be surprised if the Dollar jumps up to 200 in the worst case scenario.”
Combatting Financial Challenges
Haider stated, “although the current account deficit has reduced from $18 billion in FY18 to $12.7 billion in Jul-May 2019, such a comparison would be fallacious since the previous year’s number was too high and in fact unsustainable. In other words, a reduction was always on the cards. If this was, in fact, a major achievement, there would have been no need for the government to state that the current account deficit should be cut in half during the fiscal year 2019-20.
Haider further added, “rather than placing too much attention during public speeches on discussing long term plans for increasing exports, the need of the hour is to cut imports by whatever means possible.”
The economist concluded, “It will be a hard and challenging time for investors as disposable incomes are eroding and all salaried individuals are being heavily taxed. Foreign trips including Hajj and Umra will become increasingly expensive. It will be an extremely tough time.”