Dar’s return: A boon or a bane?

As soon as the announcement of Pakistan Muslim League-N (PML-N)’s senior leader Ishaq Dar taking over the helm of the Finance Ministry was made, the Pakistani rupee began to gain value against the US dollar. Since the formation of the new government, the rupee has been on a downward trend, losing about 56 rupees to one US dollar in the last six months. Although this downward trend was halted sporadically with the news of incoming dollar inflows, mainly from the International Monetary Fund (IMF), the rupee plunged as the interbank rate touched Rs 240. Dar faces a monumental task of not only reviving the economy, reducing the inflation rate, but also ensuring that Pakistani government is able to develop the trust of both foreign and domestic investors and foreign lenders. The challenges have been exacerbated with the flood crisis which forces the government to dole out significant funds to rebuild the lost infrastructure and rehabilitate those affected.

First, consider the current economic conditions. As Dar has been a proponent of holding the currency exchange rate of the Pakistani rupee stable at a certain value, he will not only require tapping into the meager foreign currency reserves to defend against a fall in the value of rupee against the US dollar, but also wipe out speculation in the currency market. He will need to have sufficient foreign currency reserves which increased to US$8.8 billion on September 2, 2022 after receiving the tranche from the IMF. The foreign exchange reserves held by the State Bank of Pakistan were approximately US$8.35 billion on September 16, 2022. This had bottomed out at US$7.7 billion on August 26, 2022. The foreign exchange reserves had surpassed $20 billion in August 2021, the highest ever amount reported.

The real effective exchange rate (REER) was reported at 93.2 in July 2022. REER is a weighted average of the value of a country’s currency. If it is greater than 100, it illustrates that the value of the currency is overvalued, while being less than 100 means that it is undervalued. In Pakistan, the REER has remained below 100 since June 2021. The REER was typically below 100 throughout the tenure of the PTI government, with only a few months where it had increased to levels slightly above 100. On the other hand, REER was reported to be much above 100 in the previous tenure of Ishaq Dar.

Considering the statistics on international trade, Pakistan’s exports were approximately $2.5 billion in August 2022. This means a 10.5 percent increase yearly and 10.1 percent increase monthly. On the other hand, imports were at $6.1 billion with a decrease of 7.7 percent yearly and increase of 21.6 percent monthly. The trade deficit in the first two months of FY23 was $6.3 billion, about 16.4 percent less than that reported for the same period in the previous fiscal year. In FY22, the imports increased about 42 percent while exports increased 25.6 percent. The current account deficit, as reported by the State Bank of Pakistan, in FY22 was $17.3 billion while in FY21 it was only $2.8 billion. The increase in imports, primarily driven by the increase in the imports of petroleum products, did create challenges for policymakers. They imposed measures to curtail the imports, which were unlikely to have limited the outflow of foreign exchange. Importers often find other informal channels to conduct their business when such measures are imposed, which leads to further strain on the foreign exchange reserves.

The biggest challenge for this government, as has been for all governments in recent years, is to boost the negligible level of exports from Pakistan. Unfortunately, Dar’s policies during his previous tenure may not have supported export growth as he was inward looking with his policies to fix the exchange rate.

As reported by the Business Confidence Survey, a collaborative effort between the State Bank of Pakistan and the Institute of Business Administration (IBA), Karachi, highlights the collapse in business confidence in June 2022. Business confidence plunged from the high of 64 in June 2021 to 42 in June 2022, decreasing from 55 as reported in April 2022. The current and the expected business confidence in the next six months are both below 50, indicating negative perceptions of the business community on the economic conditions. Inflation expectations have also increased while perceptions on employment opportunities have decreased. The capacity utilisation is also decreasing as businesses are curtailing operations due to the immense challenges. These twisted figures are a cause of deep concern for the economic policymakers.

In his previous tenure Dar had maintained a fixed exchange rate and enjoyed the luxury of low levels of inflation and interest rates. According to the data extracted from the World Development Indicators (WDI), the period average of the official exchange rate (PKR/USD) between 2013 and 2017 ranged from PKR 101.63 and PKR 105.46. The inflation rate was 2.5 percent in 2015 and 5.1 percent in 2018. The deposit interest rate dropped from 7.3 percent in 2014 to 4.5 percent in 2017. Global oil prices were also low, which reduced the pressure on the Pakistani rupee to depreciate as oil is the most important commodity imported into Pakistan. Dar also had a growing amount of foreign currency reserves in the earlier part of his tenure, which is likely used to defend the value of the Pakistani rupee in the latter part of his tenure, post 2016. Unfortunately, Dar was inward looking as export-oriented manufacturing activities took a hit. As per WDI, exports as a percentage of GDP declined in Pakistan from 13.3 percent in 2014 to 8.2 percent in 2017. Since then, it has failed to recover to the level reported in the earlier part of the previous decade. However, remittances and foreign direct investment did increase during the tenure. The latter is likely to be driven by the projects associated with the China Pakistan Economic Corridor (CPEC).

Dar faces different economic conditions as he takes over the reign as the Finance Minister. The reserves are depleting, and Pakistan is currently under an IMF program, which will likely limit his ability to tap into the reserves as dollar flows in from the donor agency. Inflation rates are sky high, global interest rates are rising which will likely lead to higher domestic interest rates as well. The US dollar itself is gaining strength and larger economies have struggled to maintain the value of their own currencies even after intervention in the exchange rate market. Business confidence is low, and the political environment is highly uncertain.

Dar will have to focus on increasing the dollar inflows into the economy, particularly exports. The PTI government achieved significant growth in exports given the lack of capacity and challenges associated with product diversification in Pakistan. A desire to fix the exchange rate is likely to hurt exporters and curtail channels of inflow. Dar will have to regain business confidence to attract domestic and foreign investments, introduce reforms that support business growth and, most importantly, he will have to realise that it will be different this time. The economic conditions in his previous tenure were vastly different than they are today. He may not have the leverage he enjoyed back then.

The writer is the Assistant Professor of Economics and Research Fellow at CBER, Institute of Business Administration, Karachi