What constitutes Foreign Exchange Reserves in Pakistan?
The foreign reserves of Pakistan include government’s holding of Monetary Gold, Foreign Exchange Currencies under different monetary authorities, Foreign Direct Investment, Remittances and Special Drawing Rights. SDRs refer to international asset reserve created by IMF for its member countries where SDR acts as a support fund in countries’ foreign exchange reserve when required and is subject to IMF’s approval. The SDRs are converted into many currencies in Pakistan but US dollars dominate the reserves of Pakistan.
Significance of Foreign Reserves for Pakistani Economy
Monetary Policy and Foreign Exchange Reserves
Foreign Exchange Reserve serves as one of the main factors behind formulation of Monetary Policy of Pakistan and thus, also affect value of Pakistani Rupee. The decisions taken by State Bank of Pakistan in relation to Policy rates and Money Supply is highly dependent on situation of our Current Accounts as despite an independent exchange rate mechanism, State bank has to intervene in rupee depreciation when reserves fail to maintain balance of payments account. However, the intervention by SBP is only possible when it has sufficient reserves to buy local currency against dollars.
External Debt and Foreign Exchange Reserve
Pakistan’s external debt also highlights significance of Foreign Reserves as external debt has raised substantially in past decades from $33 billion to around $115 billion in beginning of 2020. In order to service this debt, Pakistan need foreign reserves which the country lacks and thus, as estimated by IMF, under current government external debt will further rise to $133 billion in 2023 (The Tribune, 2020). Apart from this, the government has to continuously borrow expensive commercial loans from domestic banks which indicates its weak foreign reserve position and thus, affects credit rating of Pakistan. If Pakistan had large foreign reserves, the rise of external debt could be avoided. Therefore, foreign reserves can be used to pay off external debt of a country.
Economic Shocks and Rupee Depreciation
Another significant reason for aiming at increasing foreign reserves is to avoid any unforeseen economic shock or emergency. In case of shortage of foreign reserve funds, the value of Pakistani rupee can depreciate drastically as evident in 1998 when government had to seize foreign currency bank accounts to prevent default of country and again in 2001 and 2003 when Pakistan ran out of foreign exchange reserves to back up imports (Ishrat Hussain, 2003). In such cases, the rupee witnessed a free fall in market which not only affected domestic market confidence but also credit worthiness of Pakistan with international financial bodies.
How much Foreign Exchange Reserves should Pakistan Have?
The question of ideal level of foreign exchange reserves, that should be maintained by a country like Pakistan, is subjective in nature. If we look at neighboring economies like India, that has one of the World’s highest foreign exchange reserves (above $440 billion), Foreign Currency Assets (FCAs) covers the highest share. The main focus of India since 1960s has been on covering maximum period for its imports starting from coverage of 6-8 weeks of imports in 1960 to around 10 months currently. Through this, India has significantly reduced fluctuation in its exchange rate and balance of payments (The Hindu Business Line, 2019). Therefore, Pakistan needs to focus on generating enough foreign exchange reserves that should cover its imports for a longer period creating current account surplus and as Pakistan is indebted to IMF and other foreign loans, foreign reserves should also cover debt servicing of external loans.
Pakistan Forex Reserves 1960-2020
The graph below shows the increase in Foreign Exchange Reserves of Pakistan from 1960 to 2020.
Pakistan Foreign Exchange Reserve 1960-2000
The foreign exchange reserves for Pakistan have rose steadily from 1960 to 2000 which can be attributed to extremely low levels of external debts for the country till end of 1980s. Pakistan has been member of IMF since 1950 and first received loan in 1958 for $25,000. Since then Pakistan got bailed out by IMF on several occasions like Indo-Pak war 1965, 1971 East Pakistan war and later for US-Afghan War against Soviet Union in which Pakistan participated (The News, 2018). However, the expanding economy of Pakistan during that era along with strong GDP growth and lower inflation, the country did not face foreign exchange reserve issues until 1990s when PPP came into power and started taking external debts for infrastructure development and economic restructuring. The period of 1990 onwards is categorized as time where Pakistan faced challenges of corruption, high energy prices, and trade imbalance. As evident from graph, the foreign reserves remained low during 1990s till 2000 against increasing external debt.
Pakistan Foreign Exchange Reserve 2001-2020
In 2001, Musharraf’s government successfully increased foreign reserves of the country from $4.22 billion in 2001 to $15.8 billion in 2007. The main forces behind this increase were mostly positive factors as the trade gap reduced from 1.6 billion to $1.2 billion while current account surplus was achieved from a deficit of around $2 billion. Remittances increased more than double and FDI increased substantially (Ishrat Hussain, 2003). However, during 2008 and onward, while the foreign reserves increased from $13.6 billion in 2008 to $22 billion in 2016, the ratio of external debt rose more sharply thereby, reducing the Reserve to External Debt ratio by more than 12% (Rehman and Tahir, 2019).
The remittances from 2001 to 2020 have rose with little dips in 2010-2011 and 2014-2015. FDI on the other hand has been extremely unstable during this period as after a sharp rise in 2007-2008 FDI took a plunge showing lack of investor confidence in Pakistan government and rose only during 2013-2015 which can be attributed to multi-billion CPEC project.
The foreign exchange reserves again lost strength after 2016 and declined to $11.84 billion against the external debt of $27.8 billion in 2018. Since previous government’s era, Pakistan has been facing a downward trend in foreign reserves and foreign reserve to external debt ratio which indicates a threat to country’s default position.
The Rising External Debt and Foreign Reserves of Pakistan – Future Outlook
Pakistan is currently in no position to avoid external debt as the public debt is already Rs.35 trillion, more than 90% of total GDP. The external debt of Pakistan rose sharply during PMLN tenure of 2013-2018 as previously Pakistan didn’t float its Sukuk bonds in international market due to global financial crisis of 2007-2008. The Sukuk and Euro bonds along with CPEC loans, IMF loans and Paris Club has brought Pakistan’s external debt to around $105 billion dollars which needs timely repayments and thus, for coming years, government needs to borrow further external debt to service old and current debt. However, there are few steps that are already been taken and few steps that need attention of government to ensure future increased Foreign reserves. These include
- Reducing Imports of goods and services. PTI-led government has already imposed monetary restrictions on imports by discouraging them through additional duties and taxes which has reduced the trade deficit for 2019-2020 by 30% in one year.
- Improving Balance of Payments through increased Exports. An uplift of small, medium and large scale industries in this regard should be top priority of government. The increased exports in IT sector is already a positive step towards increasing foreign exchange reserves.
- The government should also maintain investor friendly environment for foreign investors after its achievement in fiscal year 2019-20 of raising FDI by 68.3% (Times of Islamabad, 2020), China being the largest contributor.
- Remittances form an integral part of Pakistan’s Forex account and under the current government, remittances have started rising again during the past six-month period by 3.3% raising levels of foreign exchange reserve to $11.39 billion, a 30-month high for Pakistan (The Dawn, 2020).
- A downward surge in oil prices has given government a huge opportunity to bridge the gap of trade imbalance and incorporate the import cost cuts in further shrinking its current account deficit.