SUBMITTED TO:

SIR SHARIQ AYUBI

SUBMITTED BY:

RAVI SHANKAR

ID: 11229

SEC: D

FINANCIAL INSTITUTIONS

RUPEE-DOLLAR FLUCTUATION ANALYSIS AND ITS IMPACT ON PAKISTAN ECONOMY

RUPEE-DOLLAR FLUCTUATION ANALYSIS AND ITS IMPACT ON PAKISTAN ECONOMY

BACKGROUND:

After devaluing of rupee by around 6% against the dollar in the first six months of FY14 (1HFY14), the rupee surprisingly appreciated by 7% in the January-March 2014 period, making it one of the best performing currencies in the world so far in this calendar year.

As the SBPs forex reserves touched a multiyear low of around $3bn in February, things seem to be finally improving, with an unexpected $1.5bn received under the Pakistan Development Fund (PDF) by a friendly nation. The surprise addition in reserves has had a knock-on effect on different speculators and exporters, who were storing dollars in anticipation of further rupee decline.

DISCUSSION

Whether the current trend is sustainable or not is difficult to answer because of lack of clarity over further quantum of receipts under the PDF. Government circles are hinting towards a deferred oil payment agreement to be signed with Saudi Arabia and Kuwait, and further receipts under PDF in the future as well.

These developments are game changers. If they do materialize, we foresee that the rupee will remain range bound at the current level throughout the calendar year. Absence of development on this front, however, will likely result in rupee devaluation.

While not denying the positives of the recent rupee appreciation, we believe that the negatives outweigh the positives, given the structural deficit issue which the country faces. Compared to $6bn in forex reserves with the SBP in June 2013, these currently stand at $4.6bn, despite the $1.5bn grant.

If this trend continues, then the trade deficit will put further pressure on precarious forex reserves.

Equity market: The impact of the rupee`s rise is overall negative, since key sectors` earnings are either directly or indirectly linked to the dollar. On the flip side, a stable rupee may lead to higher foreign portfolio investment, and an eventual inflation/interest rate decline may result in re-rating for the market.

Here are POSITIVE EFFECTS of the rupee`s rise.

LOWER INFLATION: Since a majority of the items in the CPI basket either directly or indirectly follow international prices, the recent rupee appreciation should lead to relief on the inflation front.A speedy impact will be visible in the government controlled fuel and other energy prices (electricity and gas tariffs). Meanwhile, the impact on other items will require administrative measures by the government for it to be reflected into CPI numbers.

The subsequent impact of lower inflation would be lower interest rates, which can aid in spurring domestic economic activity.

LOWERING OF FOREIGN DEBT: Another positive for the government is reduced foreign debt quantum and servicing costs. As of end of the second quarter of this fiscal, Pakistan`s total external debt and liabilities stood at $59.6bn, including government`s external debt of $44bn.

Thus, for every one rupee appreciation, the country`s total external debt and liability is reduced by around Rs60bn. At the rupee`s current value, this amount would have reduced by around RS417bn on a quarterly basis, assuming no change in the debt quantum.

Since the interest rate of foreign debt is very low, we feel that the real gain lies on account of translation gain and not savings on interest rate cost.

RISE IN FDI: Investors around the world look for consistent economic policies. A stable rupee may result in comfort for foreign investors intending to invest here, resulting in higher FDI.

Here are NEGATIVE EFFECTS of the rupee`s rise.

EXPORTS BECOME UNCOMPETITIVE: The recent rupee hike has a direct impact on our export competitiveness, especially in the context of fierce regional competition from textile export hubs.

BURGEONING IMPORTS: As imports become cheaper due to the local currency`s rise against the dollar, it will result in higher appetite for imported goods. The country already has a very high concentration of consumption expenditure (88pc) in the GDP, with a negative net export contribution. The rupee`s recent move will only go on to increase the trade deficit.

TAX REVENUES TO FALTER: A decent quantum of the Federal Board of Revenue`s (FBR) tax revenue collection is done through customs duty (12pc), so this head will suffer a shortfall. Similarly, a bigger blow will come from reduced sales tax collection on imports (22pc of FBR`s tax revenue).