11/16/2015

Who determines the rupee value! | Business Recorder

Who determines the rupee value!

November 16, 2015
ANJUM IBRAHIM
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This week's article focuses on structural and deliberate policy impediments to allow the
rupee value to be set by market conditions; next week's article would focus on the
November 2015 rupee decline and factors responsible for it.
The responsibility for ensuring a balanced exchange rate rests with the government as
well as the central bank. However, the instruments to ensure the balance are available
with the central bank though the political government does, even in some countries
where the central bank is independent, indicate what rate it perceives to constitute the balance.
An independent central bank has a number of instruments to deal with exchange rate imbalance which include (i) open market
operations for example through sale of dollars to strengthen a weakening currency with the objective of making exports
competitive - the assumption being that the central bank can out-purchase the private sector including speculators; (ii) note
printing which ideally must be at tandem with the growth of productivity and not as a means to fund the government's current
expenditure, (iii) manipulating interest rates to encourage or dampen borrowing with implications on inflation, (iv) setting
reserve requirements or how much each financial institution must hold in reserve which impacts on money supply; and (v)
disallow the government to use the central bank as a lender of first resort instead of last resort - a policy that would impact on
the exchange rate.
Four factors can negatively impact on the independence of a central bank to undertake its responsibilities efficiently and
effectively. First, legal independence of the central bank; in this context it is evident that the PML-N government has proceeded
with the necessary legislation to grant legal independence to the State Bank of Pakistan (SBP) in response to the International
Monetary Fund (IMF) condition under the 6.64 billion dollar Extended Fund Facility (EFF). However, no one is convinced that this
would be implemented in spirit. The penchant to retain control by the Finance Minister is however not unique to Ishaq Dar.
Lorenzo Bini Smaghi, member of the executive board of the European Central Bank, in his speech delivered at the conference
`Good Governance and Effective Partnership' in the Hungarian National Assembly on 19 April 2007 stated that "safeguarding
central bank independence takes more than a series of legal provisions, as the experience of the past eight years has shown.
It requires, above all, a wide degree of acceptance of the principle of independence within the underlying political and economic
culture of the society. This requires a leading role by governments and politicians.... in understanding and explaining the
fundamental reasons behind the choice to delegate powers to an independent monetary authority for the welfare of present and
future generations. Central bank independence, like any other law, needs to be continuously protected and implemented over
time. This is the responsibility of the political institutions". Pakistani politicians remain unconcerned with SBP independence
partly because the PML-N government has at present the strength in parliament to push any finance bill through and partly
because their focus and expertise remains on matters political as opposed to economic.
Secondly, goal independence is required where the central bank has the right to set its own policy goals, be it to set inflation
targets, control money supply, or allow the market to set the real effective exchange rate. However, here too there is
considerable interference from the Dar-led Finance Ministry evident from his announcements of key SBP decisions, including a
change in the discount rate, prior to the official announcements by the SBP.
Thirdly, operational independence and here the SBP does have considerable independence. However, the Dar-led Finance
Ministry initially did compel the SBP to become the lender of first as opposed to last resort though in recent months this practice
has been abandoned due to IMF pressure under the EFF.
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11/16/2015

Who determines the rupee value! | Business Recorder

And, finally, management independence; research indicates that "if a government is in the habit of appointing and replacing the
governor frequently, it clearly has the capacity to micro-manage the central bank through its choice of governors". It is relevant to
note the appointment of three governors during the five- year tenure of the PPP-led coalition government; and the resignation of
Yaseen Anwar before the end of his three-year constitutional term (he was in the job for 2 years and 104 days) considered to be
an outcome of what his supporters claim was hounding by Dar and the appointment of a pliant replacement on 29 April 2014.
A very few, in Dar's defence, may try to lay the blame on Prime Minister Nawaz Sharif given that he has emerged as a firm
proponent of a strong rupee as an indication of the strength of the economy but they would not find a receptive audience as the
primary responsibility of the finance ministry is to properly advise and guide the prime minister on matters that he may not be
proficient in. There is however overwhelming evidence since Ishaq Dar took over the finance portfolio that he places
considerable emphasis on a strong rupee as a means to understate the heavy reliance on external borrowing that has been
the hallmark of the Ministry since he took over the finance portfolio.
Dar made a disturbing admission in the Senate on Friday while urging the opposition not to mislead the public on account of
external loans by contending that total external debt would be 65 and not 68 billion dollars as contended by Senator Sherry
Rehman in an adjournment motion. Four observations are in order: (i) the Economic Survey 2014-15 notes that total external
debt and liabilities stock was 62.6 billion dollars end March 2015 which implies that total external debt incurred in just seven
months (between 1 April and at present) is a whopping 2.4 billion dollars; (ii) according to budget documents for 2015-16,
external debt was estimated at 662 billion rupees for last year which at the exchange rate of a little over 98 rupees to the dollar
(an exchange rate not applicable during Dar's tenure) gives a total of 65 billion dollars external debt; (iii) in the current year Dar
has budgeted 728 billion rupees external debt (minus 23.9 billion dollar grants) which at the current rate of exchange of 105
rupees to the dollar would imply total indebtedness of nearly 69 billion dollars by the end of the year; and (iv) all external debt is
not at concessional rate and includes very high interest bearing issuance of two billion dollars of Eurobonds in 2013-14,
another half a billion dollars issued last year and one billion dollars budgeted for the current year as inexplicably "other aid".
To conclude, the rate of exchange would determine the county's external indebtedness and next week's article would highlight
the reasons for the recent rupee depreciation.

Copyright Business Recorder, 2015

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