What next for Pakistan after second currency devaluation?

Loosening grip on managed-float operated currency has failed to prevent current, trade deficits from widening

Pakistan has allowed the rupee to weaken twice in a space of four months as it attempts to mend its deteriorating finances before elections due in July.

But loosening the grip on managed-float operated currency hasn’t prevented the country’s current and trade deficits from widening, while dollar reserves have slumped to the lowest in almost three years, prompting analysts to ask what next.

“If reserves keep going down and there’s no mechanism to finance deficits then you’re left with only one option — devaluation,” said Salman Shah, a former Pakistani finance minister. “They couldn’t support the rupee at the level it was and the central bank’s ability to intervene in the market has vanished.”

The government has few policy options as it struggles to fix South Asia’s second-largest economy. Here’s what to expect:

Rate hike

Devaluation increases the risks of inflation accelerating above February’s 3.8 per cent rate, which could force retailers to pass on costs. The central bank may raise borrowing costs by 25 basis points at its next review, according to brokerages including EFG Hermes, Foundation Securities Pvt and Topline Securities Ltd.

Another devaluation?

The central bank has been running down its reserves to defend the currency, which has been largely pegged against the dollar. With its holdings now lower than Bangladesh’s, Pakistan could completely abandon that peg and allow the rupee to free float, according to Gareth Leather, a senior Asia economist at Capital Economics Ltd.

“Given the large current-account deficit, the rupee would almost certainly fall sharply against the dollar,” Leather wrote in a note Tuesday. However, with external debt — almost all of which is in dollars — estimated at about $75 billion (Dh272.25 billion), or 30 per cent of GDP, “the authorities will want to avoid this option.”

Do nothing

The government may allow the reserves, currently at $12.1 billion, to deplete as it faces a $2.5 billion debt repayment by June, Miftah Esmail, de-facto finance minister said this week.

He denied that Pakistan would look to raise additional foreign-currency debt after a $2.5 billion bond sale in November. Kicking the can down the road will push the problem to the next administration.

“We suspect that Pakistan will continue to run down its FX reserves in the run-up to the elections to counter any depreciation pressure,” Nicholas Yap, a Hong Kong-based credit desk analyst at Nomura International (HK) Ltd, wrote in a note.

IMF bailout?

The International Monetary Fund (IMF) has urged Pakistan for years to ease its grip on the rupee. So, the recent devaluations have stoked speculation that the government may be preparing for its 13th bailout request in three decades. For now, ministers have denied they will go back to the IMF so soon after completing a $6.6 billion loan programme in 2016.

If Islamabad ultimately does tap the IMF, it would wait for elections to conclude to limit the political fallout, said Asad Sayeed, director at the Karachi-based Collective for Social Science Research consultancy.

Amnesty scheme

The government is expected to announce a policy to attract money stashed by Pakistanis abroad this month, a plan made more attractive by a weak rupee. An amnesty scheme with a flat tax of between 2 per cent and 3 per cent on top of a currency drop of 10 per cent against the dollar should be enough of an incentive, Khurram Schehzad, chief commercial officer at Karachi-based JS Global Capital Ltd wrote in a note on Tuesday.