By: Saad Khan, Arif Habib Ltd.
The Pak Rupee (PKR) on Saturday (January 7th, 2012) had shed 45 paisa’s to close at 91.3 against US Dollar (USD) in an open market while in interbank market it closed at 90.69. We initially estimated (Sept-11) that PKR/USD to move to 91.6 by Jun-12(end) and averaging at PKR 88.7/USD in FY12. However, back then we remain concerned about potentially sharper than expected depreciation in PKR may occur in the event of further deterioration in global funding. Although in the near-term, we suspect a small recovery in PKR, but we continue to hold our depreciation bias, as we do not see major capital inflows and country’s widening current account deficit.
Problem lies in weak capital inflows
Pakistan extensive reliance on foreign flows to fill in its deficit gap, which given the soggy global economic environment presents a worrisome picture. Despite global rebalancing act over a period has remained skewed towards emerging and developing markets, the prospects of Pakistan benefiting of this preference shift are fairly narrowed. Hence a turnaround in PKR does not look possible in the medium term, which could see short-term capital flows. Therefore, any recovery in PKR will heavily depend on the risk appetite of the foreign market. We recently saw some emerging economies gearing up for rising inflationary pressure as uncertainty over EU sovereign debt intensifies and have already started witnessing their currencies drop in recent months.
Weak inflows resulting in widening current account deficit
These relatively weak external inflows have pushed the current account deficit to average 4% of the GDP from an earlier 2%. Fearful of drying up foreign financial inflows has put downward pressure on the PKR, subsequently leading to inflation making it trickier to cut interest rates and to stimulate growth. While these funding of inflow deficits has resulted in overall FX outflows, the SBP’s ability to further intervene in the FX markets and uphold the parity stable is weighed down by upcoming debt repayments and the potentially adverse impact of further tightening on the domestic banking system. Consequently, PKR will continue to remain under stress.