Karachi July 5 2023: Pakistan Rupee will depreciate to 340 against dollar by end of fiscal year 2024 while recession is a viable option for country's recovery, according to Bank of America Report.
Pakistani rupee future prediction:
Pakistan is facing an acute liquidity crisis in external and domestic debt service as its options to maintain financial stability using conventional policies are shrinking. Without a comprehensive reprofiling of bulky bilateral maturities beyond 24/25 fiscal year a restructuring of commercial debt will likely also be required. The authorities may also be forced to rely on the State Bank of Pakistan (SBP) in the local market, where the liquidity crunch is even more acute. With mounting debt servicing costs,the capacity for a further “muddle-through” may be limited to near-term political cycle needs, in Bank of America view.
Devaluation of currency in Pakistan:
As a baseline macroeconomic scenario, Bofa assume real GDP growth of 2.5% in fiscal year 23/24E. A private consumption recovery after last year’s shock from floods will likely be the key driver of overall expansion. Apart from that, the bank also point out the likely robust positive contribution to growth from net export improvements due to a much weaker PKR. These two drivers should be sufficient to propel the recovery, despite the likely continued real contraction of public spending as well as gross savings, which will probably remain pressured by massive fiscal borrowing needs.
Overall, despite the strong base effect from inflationary shocks of 2022-2023, the bank think inflation will likely remain elevated at least for 1-2 more years and we expect it to be 26% by the end of next fiscal year. Thus, with high fiscal financing needs in the current challenging markets, they think the SBP may be forced to finance budgeted net domestic borrowing needs (about PKR2.5tn).
Although Bofa think the PKR might have already reached its fair value, such a policy move may push it weaker by another 15-25% from its current level or to around PKR340/$. With FX pass-through of close to 50%, the bank would expect this to contribute some 10pp to near-term inflation. On top of that, monetary expansion alone could add another 8pp to inflation in the next 12-18 months.
The key positive implication of SBP support will likely be an easing of near-term fiscal pressures as well as the likely further improvement of external balances in case of a long-due liberalization of the FX market. Both factors could pave the way for a much stronger economic recovery from mid-2024. In particular, the likely recurring current account surpluses may allow the country to start to rebuild its FX reserves, making a path for a more sustainable management of external liabilities. In particular, we think such policy moves (FX flexibility in particular) may provide strong support to a muchrequired discussion on reprofiling external debt.
A proper recession as viable alternative
In the absence of support from the SBP, we think Pakistan may be close to an outright recession in the next fiscal year. In this case, the authorities would likely be able to force fiscal financing through aggressive domestic borrowings. Massive fiscal financing needs will likely further tighten domestic credit conditions and still leave the budget underfinanced for the year, forcing fiscal consolidation across the board, constraining growth. On the positive side, inflation has the potential to slow to around 11% by the end of fiscal year 2023/24 and all the way down to single digits in the following year, at least due to the base effect from 2022/23 CPI shocks. Much tighter domestic financing conditions may also contribute to a much greater stability of the PKR, especially after its recent devaluation.
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