With more outflows than inflows,
managing the reserve position
is critical.

Having entered its sixth month in office, Prime Minister Nawaz Sharif’s government has to deal decisively with a number of urgent economic challenges even as it has taken the necessary first steps to stabilise the economy.
The most immediate vulnerability lies in the country’s external position. Foreign exchange reserves have plunged to a critical low in the past two months. This has resulted from a sharp rise in the current account deficit, with the import bill surging, capital flows at a virtual standstill and continuing external debt repayments, including to the International Monetary Fund (IMF).
Reserves have also depleted at an accelerated rate because the central bank has been intervening in the interbank market to shore up the value of the rupee. Running down foreign currency reserves to buy rupees contributed to reserves dwindling to an alarming level in early October — to just under $ 4 billion, and not enough to cover even a month’s imports. By the end of October however, reserves (held by the State Bank) had recovered to $ 4.2 billion.
This still puts reserves in the range that precipitated the 2008 balance of payments crisis. The important difference is that there is now an IMF programme in place. But more repayments loom to the IMF (on the earlier loan) and other creditors. In November around $744 million is due to the IMF as well as an unspecified amount owed to others.
An IMF mission was recently in Islamabad to conduct a quarterly review of progress as required under the Extended Fund Facility (EFF) arrangement agreed in August for a fresh three-year $ 6.6 billion loan. With this review now concluded, the IMF’s executive board is expected in mid-December to approve the next tranche of the loan — around $540 million.
Herein lies the challenge for the country’s economic managers. With more outflows than inflows expected in the next few months, managing the reserve position acquires critical importance, especially to avert any precipitous erosion of market confidence. Some analysts have critiqued the IMF programme design for not anticipating that it would take time for reserves to build and that a period when outflows could exceeded inflows (given the staggered nature of EFF disbursements and time lag for financial resources to flow from other multilateral agencies) could leave Pakistan in a precarious position.
That is true. The IMF may also have underestimated the balance of payments gap. This is why the government has asked the Fund for additional upfront money to help it tide over this fragile situation. But this still leaves the government with the daunting task of managing a tight reserve position in the next six months to meet liabilities and prevent panic in the market. This is especially so as funding committed by other multilateral institutions and bilateral partners, conditioned on the IMF deal, is not likely to kick in for another few months. The government therefore has to deftly negotiate this period and signal that it is proceeding according to a plan to address the balance of payments problem and build reserves.
In meeting this challenge the government faces an inevitable trade off, which the central bank has already been struggling with – between preserving reserves and defending the currency. Initially the State Bank of Pakistan fulfilled the “prior action” committed to the IMF by starting net purchases of foreign exchange. Thereafter it reversed course especially after the panic that gripped the currency market on 26 September.
On that day the exchange rate witnessed unprecedented volatility as market sentiment fluctuated wildly. This led the central bank to undertake almost daily interventions to shore up the rupee. The danger of panicked and disorderly interventions is that they can eventually drive the reserve level so low as to produce the very outcome they aim to prevent: A currency collapse when reserves run out.
This danger has to be mitigated by steady and proactive action to maintain the reserve level while ensuring that exchange rate adjustment occurs in a planned way rather than being driven by speculative trading or panic. This may not be easy. But the price of mismanaging the reserve level and market expectations is so high that economic managers need to carefully calibrate the outcomes and ensure that reserves are not run into the ground.
While this remains an area of vulnerability, the government has shown resolve on other fronts in taking measures for fiscal consolidation. The challenge ahead is to stay the course on budget management and also take steps to grow the economy.

The writer has served as Pakistan’s ambassador to the US and United Kingdom. This article has been reproduced from Khaleej Times.