The October 2008, crack down by FIA against exchange companies, particularly the larger ones, like the Khanani & Kalia International and Sahara Exchange, as per government claims, were primarily aimed to control the increasing price of US Dollar in the domestic market.
Subsequently tall claims were made by the authorities that as a result of these actions, a constant downward trend in the exchange rate is being witnessed and the abnormal increase in the price trend has been controlled by arresting the root cause of the situation, which according to them was due to huge transfer of funds and artificial shortage of dollars created by the exchange companies.
In addition to these charges, it was also claimed that these exchange companies are responsible for creating an economic crisis in the country and hence, the legal action against them was extremely necessary. Senate was informed by the government that it was in order to curb the informal system of money transfer called “Hundi”
“Time to shun Hundi”, Malik told Senate that the government “has determined to eliminate hundi that has the backing of certain influential.” Malik also disclosed that when he found huge amount of money transaction in Karachi, Lahore and Peshawar, it was the State Bank governor who stopped him for taking action four months ago. She contented that the forex dealers were having the license for transacting the business in any amount. After a thorough deliberation, the government had to scramble its cyber crimes wing to lay hand on this business that was ruining the economy of the country and taking the precious foreign exchange from the country away.
It was initially noted that soon after the crackdown, dollar’s price in the market came down quickly and the currency at one stage was seen changing hands between a price band of Rs. 77 and Rs. 78 in the inter bank as well as in the open currency markets for quite sometime.
However, a gradual increase in the price of dollar is being witnessed in both the markets and once again, the dollar has crossed Rs. 80/- psychological level. This up and down in the price of dollar needs to be studied carefully in order to reach some meaningful conclusion especially with reference to the claims that the rupee’s depreciation was mainly because of the ‘exchange companies.
Interestingly Pakistan’s the then Finance Advisor (now Minister) Senator Mr. Shaukat Tareen, before the FIA actions against the licensed money exchange companies, himself maintained that “Pakistan’s rupee was artificially managed between the price band of Rs. 61- Rs. 62 during Pervez Musharraf/Shaukat Aziz regime and hence needed serious correction.” According to him, the then price of dollar was artificial and its real value should have been between Rs. 80/- Rs. 82/- on the basis of country’s burgeoning current account and trade deficits, declining foreign exchange reserves, alarming increase in inflation and under achievement of all economic targets. Soon after taking over the office as Finance Advisor to the PM, Mr. Shaukat Tareen had said the constant depreciation of the rupee value was the result of wrong economic policies of the previous government which “maintained artificial parity of dollar between Rs 60 to 62, which proved a suicide for the national economy”.
He said, “The depreciation of the rupee reflected its original worth after five years of artificially-capped value. About the vulnerability of the rupee in the money market, he said: “It is being manipulated by some people for their own vested interests.” He went as far as to suggest that a cartel of banks was behind the sudden depreciation of the rupee.”
This analysis of his cabinet colleague Senator Shaukat Tareen, is in complete contrast to what the FIA and Interior Minister kept quoting to the media. They constantly told the media that the current economic crisis is mainly because of the hundi and hawala business running the under umbrella of large exchange companies especially Khanani and Kalia and hence, its top executives were arrested on charges of the same. It was even declared that FIA has unearthed the biggest financial scam of the country and has recovered huge number of funds transfer transactions that actually had resulted in dollar’s exchange price touching new highs.
It seems surprising to note a sheer contradiction between the analysis of situation by the Ministry of Finance and the Interior Ministry of State. From a hind side, the detention of exchange companies and suspending their license for an unlimited period of time leaving thousands of people unemployed including KKI and Sahara leaves so many question marks.
The biggest question arising is that when the so called culprits are no more operational then why dollar’s price is still continuously increasing since early this year and has gone up further after year end payment requirements from the oil companies, corporate customers, traders and individual customers and the announcement of federal budget. The trends are ominous, the rupee is going to remain weak or weaken further.
It is important to note that the Governor State Bank Mr. Salim Raza while speaking in the standing committee on Finance on January 28 2009 had hinted further depreciation of the rupee by Rs 2 to Rs 3 against US dollar. According to him, after burden of financing furnace oil import would be shifted on the inter bank market, rupee would find difficult to trade at the current price level and hence we did see an increase in the price of dollar especially in February 2009. and exactly the same is happening these days. The expected price of range of dollar for the coming few months is between Rs. 81/- to Rs. 83/-.
Similarly, there are rising voices about downward revision of all the economic targets for the current fiscal year including that of GDP and we may possibly see a downward revision of growth target as IMF is sure that Pakistan would never be able to achieve 3.4% GDP target that was initially set under the present circumstances.
Yet another question arises that, if the illegal business of currency has been curbed which was the biggest cause of financial shortfalls in the country and led to go to IMF to avoid a possible default then, why government, now, is looking to negotiate yet again with the IMF for additional loan facility of around US $ 4.5 billion? Doesn’t it mean that either the illegal business is still going on or still investors are taking out their money from the system through other sources which may be still operating in Pakistan or the relevant authorities probably jumped to conclusion much before investigating the real causes?
The general answer to all the questions mentioned above is the simple fact that rupee has depreciated mainly because of technical and fundamental reasons and Pakistan’s economy is still under performing, leaving very little chances of a major rebound in national currency’s price especially against dollar. Very little has been achieved on economic grounds in the last 18 months that and its clear that we would see rupee trading higher in the coming months as well. The economy is still giving a gloomy picture that erases any substantial respite for rupee in the short as well as in the long term.
In order to further justify this, let us look into the back ground with respect to the claim that rupee’s depreciation was purely because of flight of capital by the accused exchange companies. This allegation needs to be thoroughly examined due to the fact that Pakistan unfortunately has been suffering from serious economic downturn since December 2007 and hence, ignorance of all those factors that actually led to rupee’s massive depreciation is not possible at all.
To claim that rupee’s depreciation was sudden is not correct because it would betray an ostrich approach. Even if is assumed that the flight of capital was the main reason then lets not forget that the flight of capital was also seen after country’s economic reverse, international recession, political instability and then demise of Karachi stock exchange, that pushed even the local investors to search for safe heavens in order to secure their money.
Pakistan was enjoying fairly good GDP of around 7.6%, employment and development boom in many industries including IT, Telecom, Real estate, Karachi Stock Exchange was amongst the best performing stock exchanges of the world attracting huge portfolio investment, FDI (US$ 3.6 Billion approx) & exports (US $ 13.5 Billion) were fair enough to meet the set targets. Pakistan actually started to face serious economic challenges since November 2007 and still is under the same situation as no major improvement has been so far for a long term recovery.
Now with tall claims that root cause of the Pakistan’s downturn has been found, one really feels, it needs to be looked into subcutaneously. In order to understand the ground realities, it is really important to understand the mechanism of the foreign exchange markets and the phenomenon behind the exchange rates of different currencies.
Foreign exchange markets are like any other commodity market of the world, its dynamics unfold on the demand and supply. The entire market functions on the basis of these two forces. The price at which supply equals the demand of any currency, it is called the exchange price which increases and decreases on the basis of variation in these two forces respectively. The price goes up and down because of changes in the demand and supply of any currency which may take place on the basis of pure fundamental, technical and speculative reasons.
For a closer look at rupee’s fall, let us go in depth and analyze the factors behind the dismal performance of rupee especially towards the end of 2007 that continued almost till the end of 2008. It is necessary to understand that the current fall of rupee has not been ‘sudden’ as claimed by ‘some people’. Rather there was a pressure building up on rupee for sometime on the basis of certain economic factors which were related to Pakistan’s changing political, economical and security situations. Declaration of emergency:
On economic grounds actually, the country started face the consequences especially after former President Pervez Musharraf declared emergency on November 3, 2007 and suspended the country’s constitution. He defended his actions in a national address, on the flimsy ground of curbing a rise in extremism in Pakistan. The Chief Justice Iftikhar Chaudhry and other Judges of the Supreme Court were removed and incarcerated. Political and Legal implications apart, it did negatively affect the economy. Biggest fall of Karachi Stock Exchange:
Pakistan’s main stock market fell nearly 5% as investors reacted to the emergency rule imposed by President Pervez Musharraf. The fall was the biggest one-day decline on the Karachi Stock Exchange 100-share index for 16 months. The benchmark KSE index ended the day down 4.6% at 13,279.60.
The main stock index had risen more than 1,000% since the end of 2001 and reached its peak of 14,908.91 in October 2007. Since then, the KSE was not able to achieve the milestones that it had been doing before the declaration of emergency. Ms. Benazir Bhutto Assassinated In a Suicide Attack:
Pakistan opposition leader Ms. Benazir Bhutto was shot dead at an election rally that sparked riots across the country. The gunman then detonated a bomb, killing at least 15 of her supporters in Rawalpindi. Many more were injured in the suicide blast. The immediate consequence of Ms. Bhutto’s killing: KSE falls further:
The KSE continued to fall and shed around 10% in the first few days of Ms. Bhutto’s killing leaving a big question mark on the future of the country in the wake of political uncertainty and worsening law and order situation. The stock market quickly recovered from a 10% decline in the wake of Bhutto’s killing on December 27, but sentiment remained negative and the country’s law and order situation proved extremely discouraging for foreign fund managers. Portfolio investment pulls out:
The political uncertainty in wake of Bhutto’s killing caused an outflow of foreign portfolio investment from the equity market. As an immediate reaction to Ms. Bhutto’s assassination, the cumulative outflow reached US$37.163 million, leaving only $2.594 million invested. According to figures from SBP, United States and United Kingdom investors withdrew $13.3 million from the equity market on January 8. The US investors pulled out $1.183 billion, British investors $885 million, Swiss investors $56 million, Sri Lankan investors $63 million, Hong Kong investors $188 million and Australian investors $48 million. Consolidated Outflow of portfolio investment:
Fiscal year 2007-08 ending with net outflow from the portfolio investment left a big negative mark on the country’s vulnerable economic and political situation causing a total outflow of $4.6882 billion from the market.
This negative situation prevailed throughout the fiscal year 2007-2008, which was contrary to the last fiscal year when the portfolio investment added about $1.9 billion to the total foreign private investment. Political uncertainty which started with emergency, heightened with the murder of Ms. Benazir Bhutto and continued with the results of general elections stood as the biggest threat to the inflow of investments during the whole fiscal year. Downward trend of net foreign investment:
Net foreign investment declined by 38 percent during last fiscal year due to massive outflow of portfolio investment on account of political uncertainty and negative reports about country’s economy during later part of the year. Overall $3.23 billion decline in the foreign investment during the fiscal year was recorded as per statistics released by the State Bank of Pakistan in July 2008. Foreign investment (FI) stood at $5.193 billion as compared to $8.42 billion during 2006-07.
The major reason behind this dip was decline in portfolio inflows, as the foreign investors were reluctant to invest in the equity market due to political uncertainty and negative reports regarding country’s stock markets. Statistics show that FDI declined by 0.3 percent, while portfolio investment decreased by 98.8 percent. Ever increasing current account deficit:
The country’s current account deficit widened by 103% to some 8.75 percent of GDP and all time high level of 14 billion dollar during the fiscal year 2008 mainly due to the rising trade deficit on the back of high imports and slow foreign inflows. Pakistan also missed its current account deficit target of 5 percent of GDP for the fiscal year 2008, which was also higher than the State Bank of Pakistan’s projection of 7.8 percent for the last fiscal year. Official statistics revealed in July ‘08 showed that the country had faced 14.016 billion-dollar current account deficit during the last fiscal year 2008, as compared to 6.87 billion dollar in 2007, depicting an increase of 7.138 billion dollar in fiscal year 2008.
Statistics showed that principal factors responsible for the widening of current account deficit included a widening trade deficit by 15.28 billion dollar, services deficit by 6.302 billion dollar and ever highest deficit of 3.905 billion dollar in the income sector. While, the overall deficit including trade, services and income stood at 25.48 billion dollar against the current account transfers of 11.619 billion dollar.
During the last fiscal 2008, the country’s altogether income from abroad stood at 1.613 billion dollar as compared to 5.518 billion dollar payments of income to the overseas. In addition, services sector imports reached 9.89 billion dollar against the exports of 3.59 billion dollar. Swelling trade deficit:
Pakistan annual trade deficit for 2007-08 closed at $20.745 billion, which was 52.92 percent more over $13.563 billion for 2006-07 because of food import bill and steep increase in prices of crude oil in the global market. Official figures released by the Federal Bureau of Statistic showed that the country imported goods worth $39.968 billion against $19.922 billion exports during 2007-08. Monthly comparison of trade data showed that there was about 57.42 percent increase in trade deficit in June 2008 over the same month last year. The deficit was increased from $1.252 billion in June 2007 to $1.971 billion in June 2008. The deficit is $7.182 billion more as compared with the last year. Increase in overall imports:
Another disturbing factor for the economy was a consistent increase in overall imports which badly hurt the current account balance and hence the trade deficit. The import figure totaled $39.97 million in the last fiscal year leaving a trade deficit of $19.7 billion, whereas the current account deficit stood at over $14 billion. The twin deficits compounded economic woes of the government and ate in to the hard-earned foreign exchange of the country. The demand for imported goods continued to rise in Pakistan as items which were previously considered luxuries are now deemed to be necessities by those belonging to the affluent classes. The rising demand for imported goods, particularly items like luxury cars and mobile phones ate away a significant part of country’s forex reserves. Foreign exchange reserves under serious pressure:
Country’s foreign exchange reserves fell $241 million to $10.487 billion in the week that ended on July 26 2008 due to outgoings for import payments. According to official data, the State Bank of Pakistan said its reserves fell $330 million to $7.448 billion, while those held by commercial banks rose to $89 million to $3.039 billion from $2.95 billion at the end of the FY08. Total reserves at that time were down to the equivalent of less than three months of imports, raising the prospect of a balance of payments crisis unless large multilateral loans arrive soon.
Pakistan’s foreign exchange reserves hit an all-time high of $16.486 billion on Oct 31, 2007, but have fallen since then because of rising oil payments and foreign investors pulling money out because of political uncertainty, internal security situation, which accelerated very fast, after November 3 2007, Proclamation of Emergency to dismiss the non-pliable constitutional judiciary headed by Chief Justice Iftikhar Chaudhry and fellow Justices.
As a result of all these external pressures and more often then not, our own doings or more truly undoing, the rupee suffered from record lows and had depreciated above 20% during the first six months of 2008. Rupee started the New Year trading at Rs. 61/40 as against its price Rs. 87/00 in October thus showing a negative slide by Rs. 25/40 which was the biggest loss that the national currency had ever suffered in such a short span of time. The technical reasons:
The basic technical factor that spurred rupee’s fall was in fact the short supply of dollars in the inter bank as well as the open market. The demand was extremely high whereas the supply to cover it up was fairly low which naturally created a pressure on the exchange rate. The common factor in every situation was high volume buying either from importers, oil companies, corporate payments, outward remitters and individuals whereas the liquidity position of the market was never under control to give an appropriate cover.
As far as the State Bank of Pakistan is concerned, being the regulatory authority it was always into the market and hence took all necessary measures to control the depreciation of rupee. The first crisis seen in May 2008 saw central bank putting restrictions on the exchange companies which later on was followed by restricting banks in June ’08.
Despite the compliance of all the new regulations, the exchange rate unfortunately did not come under control. Realistically speaking, the major reason for not achieving the desired results is the hardcore fact that the inflows were not improving which may have supported not only the State Bank but overall financial system to run.
The State Bank’s physical intervention was there specially in the form of meeting 100% payment requirements of the oil companies but that too was already putting a lot of pressure on the country’s foreign exchange reserves and hence this strategy alone may not have helped the cause for a longer period of time. That is the reason that IMF in its initial conditions has refrained SBP to finance oil payments from its reserves and has asked it to shift this burden to the inter bank. Therefore, Mr. Salim Raza has made it very clear that as per IMF, the oil financing is being shifted to the inter bank which will surely result in an increase in dollar’s price from February onwards.
A very simple reason for the under performance of the measures taken by the State Bank before October 2008 was the fact that dollar demand was constantly going up whereas the supply was constantly going down which still is the case for increasing the gap between demand and supply and hence putting pressure on the exchange rate.
SBP had been constantly intervening in the market in one way or the other either by taking interim monetary policy measures including the imposition of higher interest rates, stricter LC margins, increased reserve requirements, and enhanced regulation of foreign exchange companies. However it is a fact that consistent increase in the level of overall imports, forward buying trend, political instability, shortage of FE liquidity to cover the market demand, absence of any concrete policy and decision making on the falling condition of our economy and ever increasing international oil prices have offset the effects of SBP steps after showing a brief respite.
Dr. Shamshad in her expert opinion, when she was SBP Governor, also said that “However, on account of the continued political uncertainty, shortfall in the foreign exchange receipts in the last quarter of FY08 and the exemption of several items from L/C cash margin requirement; pressure on the exchange rate has re-emerged in the first week of July”. Also pointed by Dr. Akhtar, “On the supply side of foreign exchange market, Pakistan received less inflow than expected” As a matter of fact, we were witnessing an extreme imbalance between our exports and imports the former showing less than expected performance while the latter, showing an all time high acceleration. January-May 2008 saw imports increase by 51% over the corresponding period last year while exports rose by only 22%. To further add to our dismay, we did not receive the expected funds from the friendly countries till June, 2008 whereas the overall inflow of foreign exchange also remained on the lower side.
Now keeping ahead all these fundamental and technical reasons, one can safely say that abnormal increase in the price of dollar was market driven. Still as pointed out earlier, rupee is looking vulnerable to more falls ahead of the year end payments requirements of the oil companies and other corporate customers, oil payments through the inter bank, still increasing trend of imports, global recession causing serious consequences to country’s exports, increasing current account and trade deficits, alarming increase in all utility charges particularly electricity and gas increasing cost of production not suitable for the producers, energy crisis especially electricity load shedding badly hurting the manufacturing sector, less than expected inflow of foreign investment either in the stocks or in development projects even by the friendly countries, growing reliance on IMF for economic miracles, lack of any serious planning & policy making to revive the economy except ever growing reliance on aid and financial assistance either from Friends of Pakistan and international donor agencies.
With the passage of Holy Month of Ramdhan Karim, the shortages of sugar, wheat flour, energy, impending winter and resultant reliance on sources of energy other than our hydro electricity, more reliance on Oil Imports, the pressures on Gas sectors, the rise of cost of dollar making life more difficult, unemployment, poverty, and hunger ought to be focus of our political leader and statesmen. Let bickering take a back seat.
Unless dollars were to flow from the coffers of friends of Pakistan, Where we are heading? Do we really have a fall back position? Time will tell!