Morning Call about Exchange Rate – Arif Habib Limited

Karachi, June 12, 2012 (PPI-OT): PKR to remain under stress

The Pakistan Rupee (PKR) continues to dwindle against US dollar, touching record low of PKR 94.80 on the interbank market and PKR 95.40 on the open market during Jun-12.

According to Arif Habib Limited, the exchange rate averaged PKR 87.32 in 1HFY12, but rose up to PKR 91.29 in 2HFY12, recording an average increase of 5% HoH. The reasons for this decline in exchange rate were mainly high oil prices and strained US-Pak relations, resulting in discontinuation of aid and suspension of disbursement(s) of payments under the Coalition Support Fund (CSF). Whilst 2HFY12 also witnessed depletion of forex reserves, widening of BoP deficit and the relative behavior of prices in different countries (as per the theory of Purchasing Power Parity) as the major causes of exchange rate decline.

Lack of foreign inflows adding fuel to the fire
During 10MFY12, remittances from overseas Pakistanis jumped by 20.2% to USD10.88bn, which helped improve the Balance of Payments (BoP) to some extent. Other factors that Pakistan was expecting to contribute to deficit financing were Coalition Support Fund (CSF), US aid, 3G auction and Etisalat payments. However, non-materialization of these inflows exerted pressure on financial account and PKR started weakening against USD from PKR 85.95 (July-11) ending up at PKR 93.66 (Jun-12), a decline of 9% YTD.

Declining Forex Reserves
Another reason for detrimental condition of PKR is the GoP’s debt repayment obligations under the IMF’s SBA, with the three tranches of USD 1.2bn and other debt obligations equaling USD1.7bn to date being made by GoP. This took SBP’s Liquid Reserves to around USD 11.5bn. In FY13, GoP is obligated to repay USD 1.53bn to the IMF, which may in return exert downward pressure on the PKR, hence threatening to further erode the value of PKR.

Purchasing Power Parity theory comes into play
Exchange rate, as per purchasing power parity theory, is affected when the two countries have different inflation rates. Economies having higher inflation demonstrate currency depreciation and vice versa due to varying purchasing power over a period of time. Pakistan’s inflation rose from 11% to 12.3% MoM (April-May), whereas inflation in US dropped down from 2.7% to 2.3% MoM in the same period. So with PPP theory holding true, PKR depreciated to record lows during this period. If this trend persists, PKR remains under a threat of further erosion in value.

In 1HFY12, SBP only intervened to balance out excessive fluctuations in the exchange market, but could not instill adequate liquidity to stabilize the market in FY12. Keeping in view the current exchange rate situation, unless proper measures are taken to stabilize it on a sustainable basis in FY13, Arif Habib Limited foresees PKR falling in a band of PKR 97-98 per US dollar by the end Dec-12. Having said that, if oil price continues to decline and also, if Pakistan receives the expected grant of USD 1.2bn under CSF and other financial assistance, the fiscal and trade deficits could be bridged and thus, stabilize PKR exchange rate to some extent.