For $12 bn IMF bailout: MPC or new body to determine dollar-rupee exchange rate

ISLAMABAD: In a bid to comply with the IMF conditions for $12 billion bailout package, the government has agreed in principle to either authorise the existing Monetary Policy Committee (MPC) or establish a high-powered institution to determine the dollar-rupee exchange rate. The IMF had asked Pakistan to shift from the managed exchange rate to market-based flexible exchange rate.

Earlier, the bank had demanded free float exchange rate. Under the new proposed mechanism, the State Bank of Pakistan (SBP) will have to ensure zero intervention in the currency market by the end of every quarter. The central bank will have the authority to intervene in day to day affairs of the currency market in order to discourage any speculation, but the intervention will be brought to zero by end of the quarter.

The IMF mission, expected to visit Islamabad by third or fourth week of April, will finalise operational arrangements to execute market-based flexible arrangement. The existing Monetary Policy Committee or a new committee will be empowered to determine the exchange rate, said the sources. This means the government’s decision to transfer the SBP’s power to determine the exchange rate to a relatively independent body with the assumption that it will take decisions keeping in view all the economic fundamentals in their broader prospective. “We are contemplating upon different options for determination of institutional arrangement for placing market based flexible exchange rate under the upcoming IMF arrangement. The existing MPC or a new high-powered committee will be assigned to determine the exchange rate on the basis of SBP’s model for real effective exchange rate (REER),” top official sources confirmed to The News on Saturday.

The gradual adjustment on exchange rate front is underway and the rupee touched 142 against dollar in the market last week. The REER is based on 2010 and now the IMF is asking Islamabad to update this model by capturing data of all those countries having trade links with Pakistan. According to the proposed strategy finalised by the Ministry of Finance exchange rate is one of the most important prices and is determined by underlying economic fundamentals. These fundamentals ensure that it would adjust to its equilibrium value over the long run. Pakistan’s approach to exchange rate management was uneven, reflecting both the realities of a thin foreign exchange market and the overriding desire to avoid unnecessary volatility in the foreign exchange market and avoid fiscal cost of exchange rate adjustment, even when it was needed. This has led to persistent overvaluations contributing to a higher trade deficit. The recent pressure on external front is no exception — a manifestation of misaligned exchange rate.

Against this background, the Ministry of Finance in its proposed strategy paper envisaged that the principle idea now is to enshrine an exchange rate policy which enhances competitiveness of Pakistani exports, by avoiding the persistent overvaluation of rupee. Accordingly, the Pakistani rupee has depreciated significantly since November 2017 and currently it is hovering around Rs142 per US dollar. The depreciation has moved the exchange rate to a level, which is more reflective of economy’s medium-term needs and market conditions while at the same time minimizing disorderly fluctuations. “Going forward, the near-term goal of this policy is to move towards a flexible regime with a transparent auction-based system with clearly defined rules; and having a safety-net in the form of an allocated intervention budget with internal controls to mitigate unwarranted volatility. This mechanism would help ensure healthy two-way movement in the PKR exchange rate, and would be compatible with the implementation of flexible inflation targeting under the SBP vision 2020”, it stated.

For exchange rate management, the government will finalise proposals to facilitate implementation of flexible inflation targeting as envisage in SBP Vision 2020. The existing exchange rate arrangements and possible limits of government borrowing from SBP will also be aligned in line with prioritising price stability as an objective of the monetary policy.