Rupee outlook dims as Pakistan struggles with debt, inflation, politics

KARACHI: The rupee is set to extend its slide into 2024 as the country grapples with high external debt repayments, dwindling foreign exchange reserves, and expected monetary easing, analysts say.

The rupee has been under pressure over the last seven years, and analysts say its woes are far from finished. It has fallen 20 percent versus the US dollar in 2023. This decline is higher than the last five-year average fall of 13 percent a year and the 10-year average of 8 percent, said brokerage Topline Securities in a note.

External financing gaps, challenging global financial markets, and local political instability have severely impacted foreign exchange reserves and built pressure on the rupee.

As per the real effective exchange rate (REER) index, rupee is undervalued. The latest November’s REER index published by the State Bank of Pakistan stands at 98.18 versus the last 10-year average of 106.6.

Considering Pakistan's external payment risk and other factors, Topline expects the currency to fall to 310 against the dollar by June 2024 in the interbank market. It also sees the rupee dropping to 325 by the end of next year. The rupee closed at 282.20 to the dollar on Wednesday, compared with its previous closing value of 282.37.

Pakistan has been grappling with record-high inflation as a result of rising energy prices to meet the reform targets mandated by the IMF's lending programme. From July through November of FY2024, the average rate of inflation is 28.6 percent. Inflation is expected to decline, supporting the case for interest rate cuts in 2024.

As significant debt obligations approach early in the coming year and the run-up to the elections, another analyst projects that the rupee could weaken to 295-296 versus the dollar in 2024. The rupee may weaken further due to expected monetary easing.

Pakistan’s external funding needs are estimated at $28.7 billion for the current fiscal year, including $24.6 billion for debt repayments and $4 billion for the financing of the current account deficit. Out of this, $5.48 billion has been repaid already and $9.3 billion has been agreed to be rolled over, according to analysts.

This result in a funding gap of $14 billion is expected to be filled by foreign investments ($1.5 billion), the International Monetary Fund’s disbursements under its loan programme ($3 billion), and loans from other multilateral creditors ($4.5 billion). After this, the shortfall in the country’s gross external financing requirements and available funding is $5 billion. However, the country’s official reserves have fallen to around $7 billion as of December 15.

When the caretaker government took charge in August 2023, the rupee came further under pressure amid speculation that the non-political caretaker setup might allow the currency to fall. As a result, the rupee fell by 6 percent (from 288 to 307) in the interbank market, while it plummeted by 10 percent (from 296 to 328) against the US dollar in the open market from August 14, 2023 to September 04, 2023.

The rally in US currency after August was mainly driven by open and black markets where the premium (open market vs interbank rate) increased from 1-2 percent to 8-9 percent.

The caretaker government, along with the State Bank of Pakistan (SBP), took several measures to cool down the demand in the open market. The measures included (1) tightening security along the border to prevent currency smuggling, (2) closure of exchange companies involved in illegal activities, and (3) an increase in the minimum capital requirement from Rs200 million to Rs500 million for exchange companies.

As a result of these measures, the rupee has gained strength in the interbank market, appreciating by 9 percent from 307 to 282 against the dollar. Meanwhile, in the open market, it has increased by 16 percent, moving from 328 on September 04, 2023, to 284 as of December 27, 2023.