Home / Finance & Market / Depreciating rupee fueling inflation

Depreciating rupee fueling inflation

Published on 29th Apr, Edition 18, 2013


There is no doubt that Pakistan suffers from cost pushed inflation. Any hike in the global prices of crude oil, crude-based raw materials and edible oil push inflation. The impact becomes even more pinching when Pak Rupee faces erosion in value against other major currencies. At present Rupee value is on the decline due to erosion of Pakistan’s foreign exchange reserves. Though, the central bank has been intervening regularly to minimize the adverse impact, its ability to intervene is also on the decline. Pakistan’s foreign exchange reserves are at 10-year low and have become a cause of concern. While there are expectations that the IMF will responds positively to Pakistan’s request for assistance, it will not be without strings attached.

This time Pakistan is likely to get assistance from IMF in the shape of EFF that will carry much higher interest rate, which will add to debt serving and can also make it unsustainable. Depreciating Rupee also adds to the quantum of debt servicing and widen budget deficit, force the government to borrow more, which in turn lead to hike in policy rate. In such a scenario IMF’s copybook reply is ‘withdraw subsidies and impose new taxes’, which further pushes up rate of inflation in the country. The goods that are likely to become expensive due to eroding value of Rupee are: POL products, electricity, industrial raw material and edible oil.

Electricity becomes expensive due to three major reasons: 1) country is heavily dependent on thermal power generation; 2) IPPs are paid in dollar terms and 3) fuel cost is a pass on factor. It is often said that IPPs are the biggest beneficiary of erosion in Rupee value as they are paid in dollars terms. Another problem is that when payments to IPPs are delayed the government also has to pay the interest rate on stuck up amounts. Pakistan often face real precarious situation when water touches ‘dead level’ in dams and power generation companies have no funds to buy fuel.

Pakistan is still heavily dependent of imported industrial raw materials for textiles and clothing industry, CKD and SKD components for automobile assemblers, pharmaceutical industry, DAP type fertilizer. At present, Pakistan faces double edged sword, crude oil prices are hovering around US$100/barrel, which keeps prices of many raw materials high and erosion in Rupee value makes these more expensive. Added to this is the burden of subsidy, which the government has to pay on imported urea, which also added to budget deficit.

With the hike in electricity and gas tariff and cost of transportation, there is also increase in cost of doing business, which erodes competitiveness of local manufacturers in the global markets. This in turn keeps exports from Pakistan low and imports high. Over the last five years, exports have grown at a slower pace as compared to imports. The net result is that despite receiving more than one billion dollars remittances per month, Pakistan’s foreign reserves have plunged to 10-year low.

With the depreciation in Rupee value the difference in kerb and interbank exchange rate widens. It has two adverse impacts: 1) people start accumulating dollars and 2) exporters keeping their remittances outside Pakistan for the maximum period. One can still recollect in nineties when Pakistan suffered from worst ‘dollarization’ phenomenon. The condition had deteriorated to a point where investors preferred to convert their wealth into dollars rather than investing in productive facilities.


In fact banks helped in creating this syndrome as they were lending up to 90 percent in rupees. The result was liquid reserves, held by the central bank, became less than dollars kept in banks by individuals and corporate. Pakistan, at this juncture faces more or less the similar situation. Another problem is that with the widening gap between kerb and interbank exchange rate overseas Pakistanis also start sending their remittances through informal channels.

With shrinking reserves exchange rate becomes volatile that further erodes Rupee value and demand starts surpassing supply. In such a scenario, it becomes responsibility of the central bank to intervene but when its own reserves are limited, often banks also start buying dollars from the kerb market. This further dents the credibility of the country.

In declining exchange rate scenario, foreign investors also abstain from investing in Pakistan. Normally there are two components of foreign investment: 1) foreign direct investment (FDI) and 2) portfolio investment. If one looks closely at the inflow of these two types on investment, it may be said with some level of confidence that over the years FDI inflow has virtually dried. The portfolio investment is there but it is mostly confined to around a dozen listed companies.

Another disadvantage of rise in portfolio investment is that while quoted prices of shares go up, there is virtually no increase in productive facilities. However, the real issue is increase in outflow of dollars when these companies declare cash dividend.

Many of the securities analysts also get jittery with this phenomenon because of rising stake of foreign investors in local equities markets. One of the fallouts is that as and when these investors decide to divest price of those share go down substantially. Though, local investors often emerge immediate buyers as local and foreign media often term this ‘panic selling’.

Though, this may sound out of context but ‘irresponsible’ reporting by media creates more problems. In the recent past on a few occasions when selling was witnessed local newspapers used terms like ‘market crashed’ or ‘market fall like house of cards’. This was totally incorrect because the KSE-100 index lost around 500 points, which was around 1.5 percent. This kind of fall is termed ‘normal correction’ by analysts.

The size of Pakistan market often becomes an impediment. If a foreign investor decides to invest one million dollars in Pakistan’s equities market, in that amount it can become one of the major stakeholder in big corporate and also the single largest stakeholder if the amount is used to buy shares of a small cap company. This is one of the reasons the leading foreign fund managers often prefer to stay away from Pakistan.

Check Also

Irregular migrants - an impact on remittances

Irregular migrants – an impact on remittances

Every year billion of dollar or payment sent by overseas to their home countries. Over …

Boosting blue growth through development of maritime silk road

Boosting blue growth through development of maritime silk road

The Gravitational forces of global geopolitics and geo-economics is moving back towards East from the …

Leave a Reply

Your email address will not be published. Required fields are marked *

çeşme escort izmir escort bayan izmir escort bayan izmir escort bayanlar denizli escort bayan antalya escort bayan antalya escort bayan antalya escort bayan konya escort bayan ankara escort bayan alanya escort bayan izmir escort bayan