ISLAMABAD: “You take the blue pill – the story ends, you take the red pill – you stay in wonderland,” probably the most famous quote of the mind-bending movie Matrix.
It seems that the current economic managers have ditched the blue pill (the theoretically correct thing to do – hike interest rates to manage inflation, devalue the Rupee to get a hold on the balance of payments) in favour of the red pill (counter intuitive, but with measures tailor-made for Pakistan – don’t hike rates as they worsen the fiscal equation, appreciate the Rupee to counter inflation, debt & purchase power). The problem is no one knows “how deep the rabbit hole goes”. Without high-impact reforms, some of which have started, we will only be fooling ourselves.
Optics matter
Just a few weeks ago, businesses were talking about shutting down & almost every professional was talking about leaving Pakistan. This has changed significantly since then, and much of it is because Rupee has appreciated 8% since its low, and economic leadership has started talking about turnaround – both enticing confidence.
Inflation Woes
However, this job is not complete till inflationary pressures don’t subside. Just like enforcing a crackdown on border smuggling & hawala business did much good, the danda should now come down on hoarders of food items & related mafias. Those producers who immediately hike rates when fuel prices go up should be first taken to task if they do not revise rates when fuel prices come down. Monitoring of prices in food (milk/meat/minimum purchase prices/etc.), industries & transport should be prioritized.
The 285 level
Last week, the USDPKR pair came down by about Rs 5. It fluttered, vacillated, and paused at 285 before yielding to the 1 rupee per day ritual, which has continued for the last 24 trading sessions. Premiums also came up that day, but it was just only temporary. 285/$ was a sound fundamental level, as the real enemy of businesses is volatility. Below 285, exporters will have a tough time keeping their margins intact, importers will have to manage substantial inventory losses, and IMF will have to be persuaded to look away from REER-based Rupee valuations. Currently, REER in our estimate is at 102 with yesterday’s closing & could make IMF uncomfortable.
Currency Outlook
But it is what it is, and judging from the current price action, the Rupee looks all set to breach the 280 level and only get some resistance near the 275 level. The 275 level is simply a ‘goal-based’ level – that some consolidation at that level should be acceptable to all. The following factors will also cause the Rupee to consolidate
– IMF appears to be heading towards giving a go-ahead, and another tranche will give wings to Rupee
– Closure of the Afghan border has decreased smuggling, especially of gold, which was the prime mode of wealth transfer
– The current account is expected to clock in a surplus, with remittances expected to give a pleasant surprise
– Restrictions of items of Afghan transit
– A further decline in oil prices will be very helpful to the balance of payments
There has been feverish interest in booking forwards by exporters, but at these levels, we recommend locking in the current rates only on the basis of the cost of their current orders in hand, without any speculative trades.
Stronger for Longer
So, while it seems that Rupee is heading towards “Stronger for longer” the two key risks are 1. political turmoil & 2. IMF acceptance. Both, which we assess, are in control at the moment.
US Bond Yields continue to surge
The last time US bonds popped over 5%, my bank in Pakistan asked me to cut my credit card limit by half (Ha!). But really, that’s how far impacting US Bond yields are in terms of draining liquidity. The last time yields were over 5%, it preceded the haunting 2008 crises. Today, US bonds are trading at the highest level this millennium and ensure America follows Europe in recession. The bond carnage has led to the collapse of the equity risk premium on the index and earnings, and the credit cycle has turned paranoid with a 13% plunge in crude oil & a 6% plunge in gold.
NPF Report
Treasury yields surged to yet new yearly highs this morning after the NFP (nonfarm payrolls) report showed that the US economy added far more jobs in September than economists expected, 336k against market expectations of 170k
Oil – Supply and demand may tilt
While OPEC+ has announced that the output cut will continue, no one is paying attention to them. The demand destruction is so loud & clear that the oil equation is no longer about supply. While we may see some further weakening of oil prices, the recent escalation of Russia on Ukraine will be a wild card.
