Finance Minister Ishaq Dar has finally blinked in his standoff with the IMF over the value of the rupee, taking the interbank price cap off. The move led the local currency unit to slide by 9.61 per cent in a single session. The rupee closed at Rs255.43 to a dollar in the interbank market on Thursday, down Rs24.54 from the previous day’s Rs230.89. This is the largest depreciation of the rupee in a single session in rupee terms, and second only to the 9.9 percent slide recorded on October 26, 1998 in percentage terms. While this is a drastic depreciation, the markets have seen it as a much-needed correction and a much-awaited step in the right direction, bringing the rupee’s official exchange value more in line with its fundamental strength. Investors are also bullish on the move because it indicates that Pakistan is receptive after all to the IMF demand for a free-floating rupee, paving the way for the revival of the stalled review talks for a bailout that could unlock billions of dollars in IMF support. Their sentiments were duly reflected in a rally on the PSX on Thursday, with the benchmark index gaining more than 1,000 points to breach the 40,000 mark. Anybody expecting the black market to quickly embrace the more realistic official exchange rates may have to wait, but the fact that the black market saw little activity on Thursday should be seen as an endorsement of the removal of the artificial price cap.
This brings us back to the question asked in these columns several times since Dar’s return: why try to drive a hard bargain with the IMF when our economy lacks the wherewithal to sustain such a tug of war? Now, we can ask in addition: would it not have been better to have relented a month or two back? The Extended Fund Facility (EFF) would be on track and our foreign exchange cover would be less precarious than it is today. The desolation that the administrative curbs on LCs have wrought would have been avoided. Exporters would have less of a compulsion to hold their hard currency proceeds abroad, and expat Pakistani workers would not be forced to turn to the black market for remittances. But most important of all, from the point of view of the ruling PDM coalition at least, the government would still have some credibility left. But that was not to be, and here we are eating humble pie after taking a thorough battering from the market forces.
In any case, as the markets have indicated, this is a welcome move. The banks are free again to quote rates based on market fundamentals. It was Dar’s insistence on a price cap that constrained the rupee’s movements in a narrow band, incentivizing black market transactions. In time, the open market rate will swing back closer to the interbank rate. Exporters will both gain a price advantage and lose the incentive to stash their dollars abroad. Workers will return their home remittances to banking channels. Finally, because a free-floating rupee was one of the major stumbling blocks in the way of the ninth review of the EFF, the development paves the way for the authorities to mend fences with the Fund. Hopefully, with the bailout programme back on the rails and the EFF funding on tap again, Pakistan’s access to bilateral and commercial financing will improve. In the longer term, a market-based exchange rate will also encourage FDI – creating the right conditions for Pakistan’s economy to climb out of the rut it has been stuck in.
The only remaining risk at this point comes from politics. If PM Sharif was looking to sweeten the economy ahead of the polls, he has clearly missed that bus. In the immediate term, the exchange rate correction is bound to unleash a flood of inflation on the back of a rise in fossil fuel prices and other imports. A spike in pump prices alone is sure to wreak untold havoc on the purchasing power of the common citizen. But this pain is vastly preferable to the desolation we risk if we stop short of taking the tough measures needed to put the economy on an even keel. The PM's job now is not to stop at half measures, but to push through all the painful economic reform necessary for the revival of the IMF programme. Unbudgeted subsidies have to either go or be fully financed by fresh revenue streams. The primary surplus that Pakistan is committed to returning at the end of this fiscal is an absolute must. The government has no choice but to quickly come up with new sources of revenue. Sharif can sweeten the ballot box all he wants by throwing targeted subsidies to help the poorest of the poor – as long as these are fully funded. Anything short of the above will be an abdication of duty, and it is difficult to see how he can hope to salvage the political fortunes of his coalition by not doing the needful.
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