State Bank of Pakistan has successfully delayed any rapid adjustment in its value by aggressively participating in the market


Aug 23 - 29, 2004





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 continue.



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 pressure.


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.


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.