SPEAKING at an event in Washington DC, both the finance minister and the State Bank governor went to extraordinary lengths to deny that the programme with the IMF contains any preconditions related to the value of the currency, or the future direction of interest rates.

Finance Minister Ishaq Dar described himself as `allergic` to talk of forced devaluations. `The market determines the value of the currency,` he insisted and emphasised repeatedly that hewould never negotiate over the value of the rupee.

SBP Governor Yasin Anwar echoed these sentiments on interest rates. `There is no dictation on interest rates, he emphasised, describing himself as the head of an autonomous policy body that makes its own decisions.

But the minister did not rule out any intervention required to shore up the rupee against `speculative moves`, saying that in his opinion the rupee remains excessively devalued. `In myopinion it should be at 100 to a dollar right now,` he said.

Sitting next to him, the State Bank governornodded.

Talk of an IMF-driven devaluation and interest rate hike has been encouraged by some language in the Fund`s own report accompanying the programme. Fund staff note that amongst other things, the programme aims to `reverse...accommodative monetary policy, and low reserve coverage which provides few buffers to absorb shocks`.

In fact, accumulatingreserves is the biggest priority of the Fund programme, and the World Bank also described it as the `most pressing short-term economic challenge` for Pakistan, in itsSouth Asia Economic Focus report released at the Annual Meetings, noting that in September, foreign exchange reserves in Pakistan had dropped to cover less than 1.2months of imports.

Measuring reserves can be a complex business. Typically the Fund calculates a net position by taking the total dollars in the country and subtracting the portion that is borrowed from abroad or otherwise pledged away domestically in complex financial instruments known as swaps and forwards. The Fund programme targets a rise in reserves by almost $2 billion in the first year of the programme, a target that will constrain the ability of theState Bank to spend dollars to support the rupee.

The reserves target laid out in the programme presents other challenges as well. The programme assumes that $1.2 billion will come from a 3G auction in the telecom sector, and another $800 million from privatisation proceeds, targets that the government has struggled with in the past.

The relationship between reserves and the exchange rate can be thought of as a choice between building your house with straw or withbricks. Straw is easier to build with, but one gust of wind will bring the house down. Bricks will withstand stronger gusts of wind, but it will take a lot of hard work and time -in short, sacrifice to build that house.

Similarly, Pakistan can choose how it wants to use the dollars that flow into the country. We can squirrel them away as reserves in preparation for a windy day in the future, or we can pour these dollars into the money markets to shore up the value of the rupee in the present.

Since the rupee tends to fall in the market when dollars are scarce, ensuring a large supply of dollars would ensure the local currency keeps its strength, but it would drain the reserves, leaving us vulnerable and exposed to the slightest gust of wind.

This is a delicate game to play. Letting the currency fall carries a political cost, and fuels inflation and raises the price of oil, our largest import. But letting reserves fall carries us towards a large scale economic crisis instead.

A middle ground can be extremely difficult to find.

Last year, for example, the State Bank spent more than $3.5 billion holding up the rupee as dollars drained out of the economy due to a large current account deficit and huge debt repayments.

Eventually, the reserves ran so low that we had to go back to borrow from the IMF Salim Raza, former State Bank governor, says that if reserves are inadequate the State Bank is powerless to even check the trend of a declining rupee, let along reverse it. Lacking reserves, the only instrument left to support the currency is interest rates.

`The choice is ours, much higher interest rates or a weaker rupee?` he says, pointing out that higher interest rates will mean higher debt-servicing costs for the government, almost Rs100 billion additional for every percentage point hike.

This is the tightrope that the finance minister and the State Bank find themselves on in the first year of the new government. But the key to holding one`s balance on this tightrope might well lie on the fiscal side of the equation, where the challenges are no less delicate.