While pressures have been building on the rupee for
some time on the back of a fast growing trade deficit, rising inflation,
corporate debt payments and heightened speculative activities, the State
Bank of Pakistan (SBP) has successfully delayed any rapid adjustment in
its value by aggressively participating in the market. Based on the
fundamentals, rupee is expected to depreciate by about 3 to 5% during
the current financial year. The rupee has been under pressure for a
number of fundamental and speculative reasons. It is worth understanding
the situation particularly because the country is expected to experience
cost-pushed inflation due to depreciation of rupee and some adverse
impact on the investment.
Pakistan meets a large portion of its capital and raw
material requirements through imports. With Pakistan's economy entering
growth phase, imports have shot up, leading to a trade deficit of US$
3.2 billion during the last financial year. The trend has continued in
July 2004 as well. According to provisional figure released by the
Federal Bureau of Statistics (FBS) Pakistan's trade deficit shot up by
73% YoY to US$ 189.4 million on the back of a 33% YoY jump in exports
and a 37% YoY jump in imports. While the government has set a trade
deficit target of US$ 3 billion for the current financial year, the
preliminary analysis raises concerns. Trade deficit for the ongoing
financial year is likely to be closer to US$ 4 billion due to the recent
liberalization in import regime, high oil prices and the increased
competition that is likely to be evident in the export markets in the
WTO governed environment.
Inflation continues to be a worry for the government.
While core inflation during last financial year remained below 4%,
headline inflation reached 4.6% primarily as a result of high food
prices. This year the government seems to be gearing up to ensure that
the wheat debacle witnessed last year is not repeated. However, it seems
to have run into a bit of a problem due to some of the conditions
included in the tender, which led to cancellation of the last tender for
500,000 tonnes wheat in the recent past. Even though the government has
indicated that it will import one million tonnes wheat this year, there
are clear indications that more may be required to enable the government
to raise its local stock levels.
It may be worth noting that the government has
indicated a target of 5% for headline inflation for the current
financial year. This target is higher than last year's inflation figure.
Whether or not this target is met or exceeds will depend on three key
factors: 1) future movement of local food prices, 2) the degree to which
the government is willing to cushion the impact of high international
oil prices on Pakistani consumers and 3) the aggression with which the
SBP deals with the issue of high real estate values affecting the CPI
through its impact on rent.
It has been noted recently that a lot of industrial
importers have been buying US dollars in the forward market in
anticipation of the possible decline in rupee value. This has put
further pressure on the exchange rate. The activity intensified possibly
in anticipation of the release of the July trade and inflation figures
and the US$ 100 million debt payment to be made by Pak Arab Refinery
(PARCO). According to some reports, the SBP got involved quite
aggressively by selling US$ 25 million and pressuring PARCO to defer its
payment. Furthermore, it has been said that the SBP had called banks and
warned them against making quotes below certain level. The seriousness
of the situation can be seen from a statement from the SBP Governor
stating that the central bank had sold US$ 700 million over the last 3
months to contain rupee depreciation.
The country's forex reserves have been witnessing a
declining trend. Forex reserves stood at US$ 12.094 billion, a fall of
4% from a high of US$ 12.6 billion at end February. Reportedly the
central bank had sold US$ 700 million during the past 3 months to
stabilize the rupee. Moreover, it is expected to sell further dollars to
shore up the rupee. In its Monetary Policy statement for the first half
of current fiscal year, the SBP stated that pressure on rupee would
The SBP has been aggressively protecting the rupee
from the free fall as per its Monetary Policy Statement. However, the
overall consensus is that the rupee will be allowed to adjust its value,
albeit gradually, based on fundamentals. Though, one expects the SBP to
aggressively counter speculative trading, it may allow the rupee to
depreciate by about 3 to 5% during the current financial year.
Therefore, it may be of some interest to understand the impact of rupee
depreciation on some of the key sectors of the economy. A report from
KASB Securities recently explored the potential impact of rupee
depreciation on various sectors.
A weak rupee means a positive outlook for PTCL. About
1/4 of company's revenue is dollar-based. Therefore, its revenue is
expected to improve, in rupee terms, with the depreciation of rupee.
Saying this, it should be kept in mind that PTCL has also disclosed an
ambitious expansion plan involving a substantial import of equipment.
Therefore, with the frontloading the margins may also come under
There will be no direct impact on the urea fertilizer
sector as local prices have very little to do with international urea
prices. However, some impact will come through (I) a relatively higher
increase in feedstock prices and (II) hike in capital expenditure of the
urea manufacturers. The country needs to import about 200,000 tonnes of
urea, which will not only require additional foreign exchange and will
also led to higher landed cost of the commodity. Since the government
wishes to further reduce the local urea prices, any increase in landed
cost of urea will have a negative impact on profits of the sector
players. As far as DAP type fertilizer is concerned, the marketing
companies are likely to pass on the entire price increase to end-users.
The movement in the exchange rate directly affects
the auto sector, primarily because vehicles are assembled locally from
Completely Knocked Down (CKD) kits imported from the Far East. The
assemblers make payments in the relevant foreign currencies to their
suppliers. However, under the SBP regulations, the payments have to be
first converted from rupee to US dollar and then to the third currency.
Therefore, in a situation where the rupee is depreciating against
dollar, as is expected, the assemblers' variable costs will also rise,
thus putting pressure on their margins. This effect will be multiplied,
if the dollar parity against the third currency also changes.
OIL & GAS
The entire oil industry is likely to benefit
positively from the rupee depreciation. With oil prices denominated in
US dollars, upstream oil and gas companies would see their rupee margins
increasing even if crude prices remain stable. The refineries and oil
marketing companies are also likely to see positive impacts owing to
their return being calculated as a percentage of the selling price. Gas
distribution companies are expected to remain unaffected as their return
is being calculated as a percentage of their net operating assets.
However, any increase in wellhead gas prices will translate into higher
gas tariffs. Since both SSGC and SNGPL are undertaking aggressive
expansion plans, there capital expenditure, in rupee terms, will also go
up and in turn force them to borrow more.
Independent Power Producers (IPPs) are widely
recognized as a dollar bull industry. With tariffs denominated in
dollars, IPPs will be positively affected by the depreciation in rupee
value. However, most of the IPPs have dollar denominated debts also.
Those companies that are regularly obtaining forward cover on their
foreign exchange payments will not see any negative impacts. On the
other hand, IPPs with un-hedged dollar denominated debt would see their
rupee converted interest costs rising. The higher bulk power purchase
cost will negatively affect WAPDA and KESC unless electricity tariff is
adjusted upwards. It creates a serious dilemma because the government
wants to bring down electricity tariff in the country.
An appreciation in the dollar is likely to have a
two-pronged impact on the textile sector through 1)
an increase in revenue (in rupee terms) and 2)
a rise in the cost of imported machinery. A stronger dollar results in
higher sales by the manufacturers and in turn translates into greater
margins for the industry. But any rise in the dollar is also likely to
raise the cost of BMR and expansion being carried out by textile
companies. It is perceived that an overall increase in sales should
offset the rise in capital expenditure. A strengthening of dollar bodes
well for the textile sector.
The strengthening of the dollar is likely to lead to
an increase in the dollar deposits at banks, with a simultaneous
decrease in rupee deposits. In case this shift takes place at a drastic
pace, banks could face problems in expanding their consumer finance
offerings. Banks will also be forced to offer new dollar based saving
schemes to attract investors. Last, but not the least, a rising dollar
is likely to lead to higher "Income from Dealing in Foreign
Currencies" for the sector. Consequently, the net impact on the
banking sector of an appreciation in the dollar will depend on the pace
of its rise. While a slow rise should result in higher Other Income for
banks, a sharp move towards dollarization could disrupt ongoing
developments in the sector.
It may be said that the SBP has enough foreign
exchange reserves to keep the exchange rate movement within a specified
bandwidth but the central banks cannot continue this indefinitely. Let
there be no ambiguity that the SBP will follow a crawling depreciation
of rupee. Therefore, it is the responsibility of all the stakeholders to
watch the exchange rate movement very carefully and also take measures
to minimize the adverse impact of rupee depreciation.
Keeping in view the persistent higher crude oil
prices, it has also become imperative for the policy planners to exploit
alternate energy resources available in the country. A lot has been
talked about the benefits of coal. It is the time to make it the
reality. Till coal becomes a preferred fuel, efforts should be made to
optimize energy cost.