ERODING FOREX RESERVES AND GROWING EXCHANGE RATE VOLATALITY

ADMINISTRATIVE MEASURES CANNOT YIELD RESULTS WITHOUT CONTAINING CURRENT ACCOUNT DEFICIT

SHABBIR H. KAZMI
Sep 1 - 7, 2008

Lately, Pak Rupee has shown a declining trend in value against all the leading currencies. While erosion in rupee value is simple demand and supply phenomenon, some of cynics term its failure of foreign exchange management regime of the central bank. There are growing concerns that depleting foreign exchange reserves, also causing volatility of exchange rate are the serious issues. There are also growing concerns that erosion in reserves and depreciation in Rupee value cannot be contained through administrative measures.

It is on record that Rupee has been depreciating against all the major currencies and the economic managers are also fully aware of the factors responsible for this. However, it is necessary to reiterate that the factors contributing to depreciation are both controllable and uncontrollable. One of the key factors responsible for rising oil import bill is hike in crude oil prices. This is not unique for Pakistan because all the non-oil producing countries face similar situation. However, the regrettable point is that the economic managers as well as the business community in Pakistan has been failing in putting up appropriate measures for containing oil import bill. It may be true that there is no shortcut to overcome this but a little effort by every individual to cut down energy consumption can help in containing oil import bill.

Though, it is a very late decision, the central bank has decided to demand 100% margin against import of luxury items. However, this has initiated an interesting debate about what are the luxury items? It goes without saying that once Pakistan managed to build up reserves, the government also liberalized the import regime. Most of these imports fall under the categories without which people have been living and can also live without these.

As the country faces a serious problem some of the policy makers are seeking easy solution and recommend borrowing for the settlement of outstanding/future liabilities. However, they forget that deferring payment of a liability may be easy but settling accumulated liabilities become a huge task in the absence of appropriate measures. The philosophy must be resisted at all the levels because it does not provide a sustainable solution.

The Policy planners are also seeking support from Saudi Arabia and other friendly oil producing countries for deferred oil payment facility. Pakistan has taken benefit of this in the past and should also avail this facility but in the mean time the focus should not move away from boosting exports and containing import of luxury items.

It is necessary to appreciate the role being played by the central bank. Like any other central bank it has the responsibility to make two way interventions, buying out dollars if its supply increases and vice a versa in case demand surpass supply. Over the last one decade it has successfully discharged its duty. Many of the critics opposed buying of dollars from the curb market but the policy helped in building reserves to record levels.

Lately, the central bank also withstood pressure of rising oil import bill by providing forex to oil importing entities rather than asking them to buy from the foreign exchange from the interbank market. Better control over money changers/exchange companies has also helped in checking flight of capital. However, many of the factors are beyond the control of the central bank. Therefore, it may not be right to put all the blame on the central bank for eroding foreign exchange reserves and volatile exchange rate.

There are many reasons for growing current account deficit on which the central bank has no control. For example growing trade deficit is mainly due to rising oil import bill and unless appropriate measures are taken to contain oil import the pressure cannot be released.

Another key reason for the mounting current account deficit is virtual halt in FDI, portfolio investment and SCRAs. Most of the government endeavors were stopped prior to completion of five-year term. Not much could be done during the interim government regime because it did not have the mandate and the new elected government is still engrossed in 'other issues' and has no time to look at some of the contentious issues facing the country.

During the rime of Shaukat Aziz transfers from the US government for logistic services were also available. However, lately the scenario has changed. Now the US administration accuses Pakistan of not taking enough measures in war against terror. On top of this growing unrest in Pakistan due to intensity in the activities of militants has also annoyed the US administration.

Privatization program was put to halt due to election but now it is more than 18 months that no move has been made. The new government has not been able to put in place and pursue its privatization policy. Some of the transactions, which were close to complete are still not concluded.

Reemergence of dollarization culture is a dangerous trend. After the plunging of stock market in persistent bearish spell, investors have opted for investment in gold and real estate. This is evident from growing foreign exchange deposits with the commercial banks. It is also on record that money is being sent to UAE for investment in real estate projects.

The way forward is the present government removes all those factors contributing to political uncertainty and improves law and order situation in the country. In order to improve supply of dollar efforts should be made to boost exports and contain imports. However, this is a long drawn process and all the stakeholders have to be involved in it.

Measures have to be taken for discouraging dollarization in the country but the target cannot be achieved simply by 'lip service'. First, incentives have to be provided for saving and then return on investment and security of investment have to be assured.

In the recent past inflow of FDI and SCRAs have played a vital role in building foreign exchange reserves. The new government must try to conclude all the transactions deferred due to election.