THE increasing demand for dollars in the wake of surging imports and debt repayments has put significant pressure on the country`s exchange rate in the last few months.
Deterioration in the exchange rate was expected following the government`s decision to combine an expansionary fiscal policy with an accommodating monetary policy to push growth ahead of the 2023 elections. Since July 1, the rupee has slipped by almost 4pc to a 10-month low on the State Bank projection that the current account deficit may widen from 0.6pc of the GDP last fiscal to 2pc3pc this year on rising imports to support the growth target of 4.8pc.
Even though the rupee recovered slightly against the greenback on Wednesday, there is a wider consensus that the currency will remain under pressure in the near term in spite of clear signs of the State Bank`s intervention in the market to support the exchange rate. With the dollar gaining strength against other major currencies, the rupee may come under additional pressure. The fresh inflow of $2.8bn through the IMF`s planned allocations for combating Covid-19 challenges may arrest the rupee`s fall for now but not for long.
In the last three years, the PTI government has been successful in containing the trade gap, and consequently the current account deficit, by curbing imports. But the trend seems to be reversing as the economy picks up steam, stimulating hef ty import growth. Last year, the trade deficit clocked in at $30.8bn, up from $23.2bn the previous year. The July data shows that the trade deficit has widened by 81.4pc in one month because of a faster spike in imports compared to exports. Until now the government has been able to build reserves with the help of large foreign borrowings and deposits from friendly countries, as well as the strong increase in remittances. But for how long? The government is targeting exports of $31.2bn this year. Even if the target is realised it won`t be sufficient to close the trade gap or finance the current account as imports are anticipated to grow much faster. The projected slowdown in remittances and continued outflow of foreign private investment may complicate matters and put more pressure on the rupee. The chances of a drawdown of State Bank reserves are unlikely for now. But the surging demand for dollars may compel the government to turn to more foreign loans to support the currency, finance the current account and maintain forex reserves at present levels.
