Impact of U.S. Rate Hikes on Pakistan’s Economy

(Staff Report):-

The Pakistani rupee is pegged to the U.S. dollar, hence its value has decreased, albeit a few other factors have also contributed to the rupee’s downfall. In recent months, the rupee has fallen by over 36% against the dollar, with the dollar’s rise accounting for about 12% of the rupee’s depreciation.

The rising inflation rate in the US  triggered global repercussions, especially in developing economies, such as Pakistan, that are deeply linked to the US economy in terms of exports and the Greenback.

Pakistan’s foreign reserves have been significantly drained in recent years due to a number of factors, including a drop in exports and remittances, rising imports of oil and food items, debt repayment, supply disruptions, and reduced reserves due to foreign exchange liquidity disparities. Growing concerns about continuing the uncertain IMF rescue package, and political instability have further compounded the problem. This has led to a significant current account deficit, which the central bank has been unable to handle with the meagre foreign exchange inflows at its disposal.

In addition, investors have also pulled out funds from the market amid uncertainty over domestic economic policy. To make matters worse, due to sluggish global growth, Pakistan received less government development assistance this year than projected. Pakistan is therefore unable to prevent diminishing foreign reserve holdings, and attract adequate assistance from foreign lenders. Even if these other factors are rectified, dollar strength, owing to U.S. interest rate hikes would continue to affect the value of the Pakistani currency.

Due to a steep reduction in oil prices, the rupee has recently risen to roughly 224 rupees to the dollar, from a high of 240 rupees to the dollar a few months ago. Theoretically, rate hikes by state-owned banks might increase yields on government bonds and bills, but economic volatility has deterred foreign investment amid these uncertainties.

Equivalent to U.S. dollars, Pakistan’s total external debt stayed at USD 127 billion over the past year due to improved relations between Pakistan, International Financial Institutions (IFIs) and Washington. However, Pakistan’s overall external debt increased by Rs 6.8 trillion or 35% year on year to Rs 26.5 trillion at the end of September this year. In a single year, the external debt of the federal government, excluding IMF loans, rose to 18 trillion rupees. External debt surged by Rs 1,300 billion in net amounts. This is mostly due to the rupee’s devaluation and the country’s efforts to borrow to build up its foreign exchange reserves.

The State Bank of Pakistan (SBP) reported that Pakistan’s IMF debt reached Rs 1.7 trillion by September, up 44% from a year earlier. This is despite the IMF spending USD 2 billion less than planned during this period. Total domestic debt held by the federal government rose to Rs. 31.4 trillion, up Rs. 5 trillion (19% annually) to reach this level.