KARACHI: The current account balance of the country turned in to surplus following the State Bank of Pakistan (SBP) adopted market-based exchange rate regime.
The State Bank of Pakistan (SBP) adopted market-based exchange rate regime in May 2019. Resultantly, the current account deficit (CAD) of US$ 19.2 billion in FY2018 gradually came down to US$ 13.4 billion in FY2019 and improved further to US$ 4.4 billion in FY2020.
Subsequently, the CAD during July-March FY2021 turned into surplus of US$ 959 million on cumulative basis as compared to a deficit of US$ 4.1 billion in the same period of FY2020. Much of the improvement came from robust growth in the workers’ remittances since FY2020.
Following are some developments that have led to the sustained Current Account improvement so far in the current year:
Market based exchange rate led to a sharp reduction in kerb premium; supporting growth in workers remittances: Workers’ remittances continued to extend their unprecedented streak of above US$ 2.0 billion for the tenth consecutive month in March-2021. Notably, the monthly inflow subsequent to introduction of market-based exchange regime remains higher as compared to the average monthly inflow before the regime was put in place
This is well complemented by the entrenchment of drastic reduction in the kerb premium after introduction of the market-based exchange rate regime, which will be instrumental in encouraging any growth of remittances to flow through formal channels.
The existence of orderly foreign exchange market conditions, along with the emerging evidence that investment opportunities provided through Roshan Digital Accounts are gaining momentum, are going to support the Current Account in the coming months.
The transition towards the market based flexible exchange rate regime helped retain competitiveness in external trade. While nominal exchange rate is important, to retain external competitiveness, the inflation differential with trading partners and share of trade weight also matter. Accordingly, it is also important to note that the Real Effective Exchange Rate (REER), that accounts for these aspects, fared well after the adoption of the market-based regime in May 2019. As figure shows that REER index, relative to its level in May 2019 when the extent of overvaluation was deemed corrected, has remained relatively stable around the same level indicating that underlying competitiveness of the economy has been preserved.
Following adoption of market-based exchange rate, non-essential imports remained in check. Despite general appreciation of the Pak rupee during FY2021 so far, imports during July-February FY2021 increased by 7.8 percent (y/y). However, if adjusted for import of one-off items, which include wheat (US$ 916 million), sugar (US$ 127 million) and raw cotton in excess from same period during FY2020 due to domestic shortfall (US$ 480 million), import growth during July-February FY2021 amounts to a much lower level of 2.9 percent.
Export growth after adoption of the market-based exchange rate regime has been encouraging. After a decline in FY2020, led by the COVID-19 related disruptions during Q4 FY2020, exports during July-February FY2021 increased by 4.4 percent (y/y). The two-way movement of the Pak rupee against the US$ played a key role in stabilizing REER and maintaining export competitiveness during heightened global uncertainty. This is evident from the recovery in volumes of major exports after extreme pandemic period between April-July 2020 (Figure 3).
So far, this new mechanism has served well for rebuilding Pakistan’s FX reserve. As compared to FY2019 (US$ 7.3 billion) and FY2020 (US$ 12.1 billion), SBP official FX reserves stood at US$ 16.1 billion on 9th April 2021. Along with this, SBP’s forward swap liabilities have been curtailed to US$ 4.5 billion at present from US$ 8.0 billion during FY2019. In aggregate, country’s foreign exchange buffers increased by US$ 12.3 billion.