Currency market overreacting to debt payment

 

KARACHI: The outlook for the current account balance has been projected by the State Bank as a source of concern. However, it has expressed hope on account of strong worker remittances and possible gains on oil imports as global recession may exert pressure on energy prices.
The SBP`s annual report issued on Monday noted that the current high account deficit was a temporary situation. It explained that the deficit of the first four months of this fiscal year at $1.6 billion is because of oil payments, a seasonal pause in remittances in September 2011 and an engineered shortage of hard currency in the parallel foreign currency market.
“The market is overreacting to Pakistan`s foreign debt payments in 2011-12,” said the State Bank, adding that one must realise that while repayments on the IMF`s $8.9 billion Standby Agreement will start from this fiscal year, outflows are only $1.4 billion and are scheduled for the latter half of the fiscal year”.
The annual report said Pakistan`s economy managed to grow by 2.4 per cent in FY11 while estimated 6.6 million of Pakistan`s labour force was out of work for 2 to 3 months, and capital stock worth $2.6 billion (1.2 per cent of GDP) was lost.
The report said the overall growth in services was 4.1 per cent in FY11, which was lower than the target of 4.7 per cent, but this still accounted for 90 per cent of real GDP growth.
It said the food inflation was particularly hard hit, posting a sharp 21.3 per cent year-on-year increase in September 2010, compared with 10.4 per cent in the same month a year earlier food inflation remained about 19 per cent in the first half of FY11.
The financing of the fiscal deficit was, and still remains, challenging, said the report adding that with a decline in external funding following the suspension of the IMF Stand-By Arrangement (SBA), the government had little choice but to rely increasingly on domestic sources.
“During FY11, the government borrowed Rs1.1 trillion from domestic sources, which accounted for 91.0 per cent of the fiscal deficit,” said the report.
The report said the government`s response to the energy shortfall was threefold: rental power projects (RPPs) were commissioned to increase generation capacity; the government released Rs120 billion to resolve the interagency circular debt problem, which was undermining energy production; and electricity tariffs were increased to pass on the higher cost of production.
“In spite of these measures, the overall situation remained largely unchanged,” said the report.
The SBP said commissioning RPPs to increase generation capacity was misplaced, as Pakistan is operating well below its installed capacity due to the circular debt problem.
“One must also note that the Rs120 billion injected by the government (to restart the funding of furnace oil) only happened in May 2011. In effect, for most of FY11, the acute problems in the power sector went unaddressed.”
In terms of what to expect in FY12, especially within the context of a global recession, the State Bank said the bulk of Pakistan`s exports are low-end textiles, which are not likely to experience a fall in demand as they are income inelastic.
If anything, Pakistan`s export receipts may be hit harder by the price effect if cotton prices continue to soften. However, the negative price effect may not be as pronounced going forward, as current international prices are where they were before the spike started in mid-2010.
With the US Dollar viewed universally as the safest currency (despite serious economic challenges facing the US), the SBP said US dollar will not lose ground against other hard currencies.