Pakistan’s Third Strike Depreciation Drive

Pakistan stocks and bonds tried to shake off the third rupee devaluation since December as it touched 120/dollar for a 15% drop over the period. Foreign reserves are down to $10 billion or two months imports on a 5% of gross domestic product current account deficit, swelled by equipment imports under China’s Economic Corridor energy and infrastructure projects and sliding remittances.  The interim government recently borrowed more through Chinese banks and the bilateral central bank swap line to bolster the position and repay foreign debt, as the business and financial communities brace for possible reapplication of an International Monetary Fund program after July elections. Caretaker Finance Minister Dr. Shamshad Akhtar urged “immediate corrective measures” to restore debt and balance of payments sustainability, as Moody’s kept the low “B” sovereign rating on both credit and political risks. The PML-N party in power under Prime Minister Nawaz Sharif had basked in the glow of IMF exit and easy global bond access before the ouster on corruption charges, but his successor faces immediate cash and economic policy credibility crises that will leave foreign investors, already net equity sellers, on edge.

The World Bank predicts a near 1% GDP growth slowdown to 5% next fiscal year, as inflation veered toward that figure in May. The budget deficit could be 6.5% of GDP when the 2017-18 year ends in June, and the Bank expects fiscal and monetary tightening ahead. Massive government borrowing lifted public debt to 80% of output, and interest payments exceed development and defense spending. Meanwhile tax collection remains meager, and a future IMF arrangement will insist on more progress widening the base and targeting wealthy evaders. In external accounts, even with 15% export growth in mainstay garments and other sectors, the trade deficit was $35 billion through May, while $2 billion in foreign direct investment was the same pace as the previous year. Worker remittances were slightly up to $15 billion over the past ten months, but are projected to flag from the Gulf in particular. Higher imported oil and natural gas costs will add pressure, and gross foreign debt nearly doubled the past five years to $90 billion, over 300% of exports according to the central bank.

After tapping Chinese sources for billions of dollars in bridging facilities, the government announced in May a $200 million syndicated loan with United Arab Emirates banks. Benchmark global bond prices have fallen to new lows with the squeeze, with the 2027 issue below 90 cents. Separate plans for an inaugural Chinese renimbi-denominated “Panda” and individual investor “diaspora” bonds are also on hold, until a new debt management team is in place and current turbulence in world financial markets subsides. After the policy rate was hiked 50 basis points in May, domestic borrowing will in turn be more expensive.

Sri Lanka, where the Morgan Stanley Capital International frontier index fell 2% through May, also experienced currency weakness, despite good marks on fiscal targets under its IMF accord and GDP growth rebound to 3.5%. The central bank, which is to gain more independence and an inflation-targeting framework under a new law, continues with coordinated depreciation to try to overcome external debt at 60% of output and a heavy 2018-19 amortization schedule. Higher oil prices will boost the current account deficit and shave reserves to around five months imports, and previously loose monetary policy will likely be reversed to damp import demand and support the rupee.

Bangladesh has better 7% economic growth, lower debt and a narrower current account gap, but the IMF’s latest Article IV report warned of “slow progress” with the Rohingya refugee influx creating the world’s largest camp. An emergency international appeal of almost $1 billion is designed to obviate budget strain, as the monsoon season begins further threatening lives and shelter. Interest rates were recently cut as authorities seek to curb almost 20% annual private credit expansion through macro-prudential measures. They have also upgraded cyber-defenses after $80 million was stolen from reserves in 2016, and are considering recapitalization of state-owned commercial banks ahead of possible partial sale. However such long-overdue changes will have to wait until scheduled end-year elections with uncertain opposition party participation, as the subcontinent endures further depreciation of actual and political currencies.

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