Oct 12 - 18, 2009

Lately, a question is often asked that should the central bank play any role in containing exchange rate volatility. Various groups have different views. While some analysts strongly believe that market forces should be allowed to fix the exchange rate parity, others strongly believe that one of the prime responsibilities of the central bank is ensuring stable exchange rate. Though, both the opinions may seem contradictory, no one can deny the role of central bank in ensuring stable exchange rate.

For a country like Pakistan, often suffering from huge current account deficit, managing rate parity becomes the prime responsibility of the central bank. This intervention involves a cost, which is worth for saving the economy from shocks. The previous government is often alleged for managing the exchange rate artificially, which resulted in imports becoming cheaper. However, the critics look on one side only. They completely forget that effective management of exchange rate previously helped containing prices of commodities i.e. crude oil and POL products, wheat, sugar and fertilizers.

Though the present economic managers may not like to give any credit of stable exchange rate to the previous government, they cannot deny that substantial inflow of foreign direct and portfolio investments, privatization proceeds, and huge unilateral remittances helped a lot in maintaining stable exchange rate. However, one should also accept that internal and external economic fundamentals changed a lot soon after the new government took the control.

In 2008 prices of crude oil, wheat, sugar, fertilizer, and other commodities touched record high levels. Since Pakistan's imports are in elastic erosion of foreign exchange reserves was but natural. At the same time foreign direct and portfolio investment dried and the new government could not continue privatization program.

Bearish local and international equities market also shrank the size of foreign portfolio investments in the country.

The natural outcome was erosion of Pakistan's foreign exchange reserves to alarming low levels. However, Pakistan was not alone many economies had to bear the brunt of global economic meltdown. Governments of economically strong countries injected millions of dollars to save their economies and countries like Pakistan were forced to approach the International Monetary Fund (IMF) for assistance. This time the IMF was a little generous and also fussy in extending the support. However, Pakistan's case was weakened due to allegations of figures fudging by Ishaq Dar. Ironically Dar said two contradictory things in the same breath 'previous government fudged the data' and 'we will continue the economic policies of the previous government'.

Inability to meet the agreed target is an acceptable excuse depending on the prevailing circumstances but fudging data is an unpardonable crime. The nation is still paying the cost of this allegation made by Dar. The IMF was fully cognizant of the factors responsible for the precarious current account situation and also realized that Pakistan needs assistance to avoid default. It promptly agreed to the quantum of assistance demanded by the new economic manages and was generous enough to accept additional demands. However, the Fund keeps on raising its apprehensions regarding some structural weaknesses in Pakistan's economy and inability of the economic managers in addressing some of the contentious issues.

The IMF has provided funds which are sufficient for timely discharge of debt servicing requirements but long-term measures have to be taken by the Government of Pakistan to remove the structural imbalances plaguing the economy.

The IMF is right in a way when it demands that budgetary deficit has to be contained to stipulated levels. It is also true that instead of containing non-developmental expenditure and extravaganzas the government is very prompt in slashing PSDP.

One sees that Pakistan's liquid foreign exchange reserves are on the rise. However, the numbers look deceptive because the increase is mainly due to inflow of funds under different programs. Analysts also insist that the present economic managers are borrowing without the realization that very shortly debt servicing will plunge Pakistan in the vicious debt trap where the government will be forced to borrow for discharging its external commitments.

Analysts strongly believe that unless factors affecting GDP growth rate, fresh investment, and energy supplies are not resolved achieving exportable surplus and restoring competitiveness of the local manufacturers may not be possible. Some of the analysts recommend devaluation of rupee as one of the tool to boost exports. However, others term this a very myopic view because the cost of imported raw material, fertilizer, sugar and above all energy products would increase considerably.


The GoP has started focusing strategies to get things back on track as far as the country's return to the international capital markets is concerned. According to finance ministry officials the government is planning to launch a US$500 million Eurobond issue in 1Q10. The ministry is more likely to favor a Eurobond issue as against a Sukuk bond issue due to the collateral requirements that are attached to a Sukuk issue.

Pakistan's current credit rating is still weak, but the government may be looking to take advantage of the disparity between record-low, recession-driven, global interest rates, and inflation driven higher domestic interest rates in Pakistan.

According to Bloomberg, presently Pakistan's 2016 Eurobond is yielding 8.96% in the international bond market. Despite being the lowest level in several months, this yield is still much higher as compared to the 7% yield being sought by the finance ministry on any new issue. Despite recent improvements in Pakistan's credit rating, its internal fiscal and monetary issues have kept local interest rates higher.

By looking at the finance ministry's initial working it seems as if optimism has developed for the Eurobond issue based on the recent success (five time over subscription) of a Eurobond issue by Cyprus. Cyprus launched a US$1.5 billion, 3.75% bond due in 2013. However, it is pertinent to note that the credit rating for Cyprus stands at A+.

It is believed that if the country is to issue a US$500 million Eurobond at this time, the yield would not fall significantly from current levels. Analysts expect any 5-year issue by Pakistan to yield around 8.25%-8.50%, which would be a high price to pay considering rupee weakness. However, at this time the country is going through a phase where lack of funds may hamper future growth prospects and ability to meet domestic and international expenditures.