MULAZIM ALI KHOKHAR (Research Analyst)
Sep 1 - 7, 2008

Pakistan has been under severe political crisis since start of the FY-08 in the name of political transition towards democracy, and this has resulted in very acute implication on the country's economy as GDP growth dropped from 7.2% to 5.8%, inflation (CPI index growth) jumped from 7.8% to 12% in a year and the rupee which stood firm at Rs. 60/$ for many years slumped to Rs. 76.7/$ very recently. The rupee has been the world's fourth-worst performer.

Although President Musharraf has left his office, the investors and the analysts' world over are still negative on Pakistan future political and economic outlook. Some are quoted by saying "Pakistan's dilemma is a fair aide memoire of the risks to investing in the emerging markets." The shaky investor confidence is sign of further slump in economy and foreign exchange if the political scenario does not normalize.


State Bank of Pakistan kept Pak-rupee firm around PKR 60/$ for about last 5 years and/or more with effective dollar floatation in the forex market. This was possible due to greater forex reserves with the State Bank. But during the last Financial Year 2007-08, the reserves have deteriorated sharply and rupee was left on the shoulders of the market forces.

The market dealt with the poor rupee miserably and rupee lost its worth of about 24% against US-Dollar when compared to Jan-2008 figures of PKR 62/$. There are many factors along with political issues responsible for the weakening Pak Rupee against already lazy US $ in the world forex markets.

The factors include:

* Sliding Foreign Reserves

* Hiking World crude oil prices and inflation

* Current account deficits with greater share representation of crude oil imports

* Worsening law and order situation

* Speculative buying of $ in the Pak forex market

* The costs to protect nation's sovereign bonds

The country's foreign reserves have declined from US $ 16.49 billion during September 2007 to US $ 9.57 billion on 21st August 2008 i.e. down by US $ 6.92 billion which was enough to cover 3 months imports bills. The reserves declined due to higher import bills especially due to high priced crude oil imports and substantial decline in country's financial accounts and the net outflow of investments in equity by foreign investors by US $396 million in 2008. The current account deficit for the FY-08 has been US $14 billion i.e. 8.4 percent of GDP and is more than double the FY-07 figures.

Owing to all these factors Pakistan's forex markets came under immense speculative buying pressure which further exploited the situation. The cost to protect the nation's sovereign bonds from default has almost tripled since October 2007 to the highest. Credit-default swaps on Pakistan's US $ 2.7 billion of bonds outstanding rose to 788.8 basis points on Aug. 22, meaning it may cost US $0.79 million annually to protect $10 million of the nation's debt from default for five years, according to data compiled by Bloomberg.


The State Bank of Pakistan through its monetary policy statement and different circulars has taken effective measures to improve reserves and control the depreciating rupee against US Dollar such as:

* Obligation on the exchange companies to surrender a minimum of 15 percent, instead of earlier 10 percent, of foreign currencies received by them from home remittances to the inter bank markets. (Circular Date: April 29, 2008).

* Another obligation on exchange companies to transfer foreign currency from their foreign nostro accounts to commercial banks in Pakistan and henceforth exchange companies will have to close all nostro accounts abroad (Circular Date: May 9, 2008).

* On July 8, 2008 SBP took the following measures with immediate effect:

* Forward booking suspended temporarily against every import,

* Oil payments from State Bank of Pakistan only,

* Foreign exchange dealing time for customer and inter-bank transactions restricted

* Prior approval of State Bank for all transactions of US$ 50,000 or above on account of outward remittances or sale of foreign currencies to the customers.

*100 percent cash against Letter of Credit (L/C) margin on the import for over 386 luxury items with immediate effect to curb imports and stabilize the rupee. (a circular BPRD-11, August 27, 2008)

The Government of Pakistan has also taken many steps to curb inflating imports in the fiscal policy, and very recently additional duties up to 50% have been imposed on the imports of luxury and non-essential items effective from Wednesday 27th august 2008.


The current account deficit needs to be addressed effectively and the Government badly needs foreign investment to improve foreign reserves. In this regard, the Government has decided to privatize OGDCL on priority basis and a loan of about US $4 billion from the Asian Development Bank and the World Bank is much awaited by the Government to support budget deficit and foreign reserves accounts. As per analysts this will stabilize the currency at around PKRs.72/$.

Another major favorable factor would be the stability of oil price which is expected to be around US$ 110/barrel. This would be highly appreciable for the country's existing trade deficits and inflation.

Going forward much depends on political forces to ensure stability through political maturity and work together towards the betterment of Pakistan. In the worsening economic scenario the measures taken by the government and SBP will not be able to help much to appreciate Pak rupee against dollar.