It is by now obvious that the party spoiler in the country is Inflation. Not only does it refuse to go away, but all other sachems are directed towards normalizing it. It is a global problem with most economies prioritizing inflation over economic growth.
Impact on FX
When Rupee depreciates, it adds to the imported inflation component. To avoid this, a policy of stable to stronger local currency has been adopted. This is part of the ‘reverse currency wars’ on which we have written earlier, with the objective to keep a cap on rising inflation.
The fiscal year started with USDPKR at 286. Judging by historic trends, an annual depreciation of 7-10% is typical, which supports the exporters and maintains REER near par. This would imply that June end closing rates would be around 310/$. As of today, Rupee is actually stronger by around 2%, and a depreciation looks unlikely.
The new government in Pakistan is unlikely to rock the boat unless inflation comes down significantly. Consequently, Rupee is headed towards a soft close by June 24 end.
Exporters, that are now fiercely competing global manufacturers and also domestic conditions like escalating cotton prices, energy and labour costs are taking the extraordinary risk of selling dollars in forward to hedge their sales & give competitive prices. Though there is a slowdown in forward booking, it is still being done by larger exporters.
There also seems to be concerted effort to keep swap premiums high amidst declining interest rates to support forward selling. SBP’s aggregate swap positions have reduced to $3.2bn from $4.5bn in June 23.
The stable currency has prompted higher trading numbers, business confidence, robust stock exchange and inflow of portfolio investment. Month to day inflows are around $46mln with about $19 mln coming through purchase of TBills by foreign investors.
Impact on Policy Rates
In a poll conducted by Tresmark, 83% of participants do not expect any rate change in the upcoming MPC on 29 Jan. In fact, majority think there will not be any rate cut for another 2 months. Here too, the party pooper is to blame. While the SBP has projected inflation to come down drastically, revision in energy prices & fuel prices will keep inflation at elevated levels.
Turkey’s Inflation Problems
Turkey increased its interest rates from 42.50% to 45%. Please read that again 45%! And yet its inflation has increased MoM and now soars to 65%. Part of their inflation problem is the spiraling currency. In spite of all the adjustments, Lira continues to fall, hitting an all-time low of 30/$ last week. One of the main impacts of this devaluation is inflation — and lots of it. It is obvious that since the people don’t trust the currency, any practical amount of rate hikes will not have a substantial impact.
Perhaps, they should look in to reverse currency wars and find a way to strengthen their currency to address runaway inflation.
