IMF reiterates rupee’s overvaluation stance

ISLAMABAD: International Monetary Fund (IMF) reiterated its stance that the rupee is overvalued by 10 to 20 percent in real effective terms but Pakistani officials say the current exchange rates would have no immediate consequences for the economy.

“Greater exchange rate flexibility, fiscal adjustment, and structural reforms would help narrow the gap,” the IMF said in a report that concluded the Article IV consultation with Pakistan.

The officials did not agree with the estimates done by the Fund staff.

The Fund said Pakistani authorities’ assessment suggested a significantly lower degree of overvaluation.

Just before the recent appointment of Tariq Bajwa as Governor State Bank of Pakistan, Pakistan’s rupee had witnessed steep decline of more than Rs3.50 against dollar in one day, but then former acting governor Riaz Riazuddin preferred not to intervene into the market. 

Finance Minister Ishaq Dar took notice of the situation and ordered an inquiry into the steep decline as well as moved ahead with the appointment of permanent Governor SBP. 

“Now a detailed inquiry is underway and its report will be submitted soon for ascertaining the reasons behind steep fall of rupee against greenback,” said an official.

The IMF, in the report, said the country’s external position is moderately weaker than what was suggested by fundamentals and desirable policies. 

“Estimates from standard methodologies for the assessment of the external position are subject to significant model uncertainty,” it added. “The current account gap (deficit) is estimated at between 1 and 1.8 percent of GDP based on the Fund-wide EBA (external balance assessment) exercise (and) this suggests an overvaluation in the 10–18 percent range.” 

At the same time, the Fund said another assessment method (the real effective exchange rate-based EBA-lite), explicitly accounting for factors such as remittances and aid flows, suggested a slightly larger overvaluation of about 20 percent. 

IMF said Pakistan’s gross reserves have remained below the adequacy level as suggested by the assessing reserve adequacy (ARA) metric – 73 percent in December 2016 – and have declined since the completion of the extended fund facility-supported program last year. 

Resumption of accumulation of reserves, including through allowing downward exchange rate flexibility, is needed to further strengthen buffers, while also supporting competitiveness, it added.

The Fund further said rising imports, stagnant remittances, and weakly recovering exports are weighing on the current account deficit, which is expected to widen to 3 percent of GDP in the fiscal year of 2016/17. 

Expected foreign direct investment inflows and significant government external borrowing in the fourth quarter would allow financing the increase in the current account deficit and foreign reserves to recover to $18.5 billion, equivalent to 3.8 months of imports and which is 73 percent of the IMF’s ARA metric, albeit with risks to the downside. 

Over the medium term, IMF said current account deficit is expected to peak at 3.4 percent of GDP in 2019 as China-Pakistan Economic Corridor- (CPEC) related imports gather steam, and could subsequently moderate as exports recover, supported by the elimination of supply-side bottlenecks and the implementation of business climate reforms. 

“Pakistan will face increasing government and CPEC-related external repayment obligations, and external financing needs are projected to increase to nearly 7.5 percent of GDP over the medium term, highlighting the need for macroeconomic and structural policies supporting competitiveness,” it said.