The Pakistani rupee (PKR) has weakened significantly against the US dollar (USD) over the last five years. Indeed, since 2020, the greenback has gained around 80% against Pakistan’s currency. Part of the reason for the rupee’s weakness is that all emerging market currencies have struggled in recent years; first, because of the instability of the Covid-19 pandemic and the flight to major currencies that prompted, and second, because of the high-interest rate environment that has been in place since 2022.
When inflation peaked at over 9% in the US, the Federal Reserve moved to hike rates significantly, to a three-decade high of 5.5%. This encouraged foreign exchange traders to reduce their exposure to relatively high-risk currencies such as the Pakistani rupee and move assets into the US dollar, which was seen to be safer and offering relatively lucrative yields.
The Pakistani rupee fared particularly badly, however, owing to the fraught political and economic climate in the country. In April 2022, the government led by Tehreek-i-Insaaf leader Imran Khan was ousted in a no-confidence vote after Khan lost the support of coalition allies and Pakistan’s military. In May 2023, he was then arrested, prompting violent clashes in Islamabad and other major cities across the country. Shehbaz Sharif is now serving as the Pakistani prime minister after controversial elections in March this year, with traders and the market still concerned about the levels of political volatility in Pakistan, potentially undermining the strength of the rupee.
Another source of pressure on the Pakistani rupee has been Pakistan’s enormous trade deficit. Pakistan has long been a consumption-driven economy: it relies on imports for essential goods, most of which are paid for in US dollars or other major currencies. These dynamics mean that the rupee is often under considerable pressure. While the trade deficit has narrowed in the last year – from $27.47 billion to $24.09 billion – the foreign exchange outflows implicated in the large trade deficit are likely to keep putting pressure on the currency.
The Pakistani central bank has responded to this situation in 2024 by managing the exchange rate within a narrow band of 274.5PKR to 281PKR. The State Bank of Pakistan notes that “to quell excessive volatility and to ensure smooth functioning of the foreign exchange market, the SBP occasionally intervenes in the foreign exchange market” but also says that “the SBP does not aim to keep the exchange rate at any pre-determined level.”
Managing the exchange rate in this way has allowed the authorities to get a grip on currency depreciation, which had threatened to stoke runaway inflation in Pakistan. In August 2024, the inflation rate in Pakistan eased to 9.6%, down from 11.1% the previous month. Exerting influence over prices in this way has allowed the central bank to ensure that standards of living are not undermined further by high inflation.
However, it is unlikely that this will be allowed to continue indefinitely. After all, Pakistan is currently receiving assistance from the International Monetary Fund (IMF) and recently agreed a package of financial aid worth $7 billion. The IMF has said that “the new programme aims to support the authorities’ efforts to cement macroeconomic stability and create conditions for a stronger, more inclusive, and resilient growth.”
However, when giving assistance of this kind, the IMF usually insists on market liberalisations, including in foreign exchange markets. This has been seen recently in Egypt and Ethiopia, where both have freely floated their currencies in order to access IMF and World Bank cash. Both countries have seen their currencies depreciate to record lows against the dollar in the aftermath.
Should Pakistan continue to receive IMF assistance, as seems likely, we should expect to see the Pakistani rupee freely floated in the coming months. At this stage, Pakistan’s political volatility, wide trade deficit, and other destabilising factors will likely prompt the rupee to depreciate further.
Author: Harry Clynch
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