Introduction
How significant are foreign exchange reserves for the average person? The average person cannot comprehend the fundamentals of foreign exchange reserves because only economists are qualified to do so. However, the general public bears the majority of the costs and burdens related to maintaining foreign exchange reserves, so we will delve deeper into this subject in this post and make it more accessible to the average person.
How to assess the needed level of reserves
A country needs foreign exchange reserves for a variety of reasons, including to meet its international financial obligations, to keep its domestic currency’s value fixed, to keep it less valuable than the US dollar, to maintain liquidity in the event of an economic crisis, to pay for internal projects, and to reassure foreign investors. The primary issue, though, is “How much of the foreign exchange reserves are regarded as safe?” The conventional “rules of thumb” that have been applied to establish reserve adequacy imply that governments should maintain reserves covering 100% of short-term debt or the equivalent of three months’ worth of imports. This is supported by several empirical studies.
Two-step approach
Based on the evidence from past crises, the IMF study proposes a two-stage approach for assessing what constitutes an adequate level of reserves for emerging markets:
First, use a new “risk-weighted” metric to assess country-specific vulnerabilities. The metric is akin to the risk-weighted assets used to assess bank capital needs and covers potential vulnerabilities from falling export income, a sudden stop in short-term debt flows, outflows from other debt and equity liabilities, and resident capital flight. It also takes into account the exchange rate regime of the country.
Second, estimating the level of reserves that might be needed as measured against this risk-weighted metric The approach is similar to that used for bank capital requirements, where needs are assessed as a percentage of a risk-weighted asset stock.
Assessing reserve adequacy in low-income countries
Access to capital markets is often more constrained in low-income nations than it is in developing economies. The question of whether this is a suitable benchmark has persisted even though the customary rule of thumb of three months of imports is frequently employed to evaluate the sufficiency of their reserves.
For the majority of low-income nations, shocks to the terms of trade, unstable assistance, foreign direct investment, and remittance flows are the main causes of drains in the balance of payments. These elements imply that reserve coverage in months of imports is still a valid metric for assessing the sufficiency of reserves in low-income nations.
Given the projected benefits afforded by reserves in lowering both the probability and effect of shocks, empirical research reveals that three months of imports remains generally suitable for nations with flexible exchange rates. However, the data implies that nations with sound institutions and policies require less in the way of reserves.
Pakistan’s foreign exchange reserves
The entire reserves of Pakistan demonstrate that they have traditionally remained at 3 months’ worth of imports. Even if from a normal vantage point, it appears to be at a comfortable level. Yet, Pakistan’s foreign exchange reserves have recently fallen drastically to worrying levels. As of January 2023, Pakistan’s foreign exchange reserves scarcely have enough money to fund a month’s worth of imports.
The Impact of Pakistan’s foreign exchange rates
Pakistan’s foreign exchange rates have dropped to their lowest since 2014, and this development has created a ripple effect in the economy, impacting the lives of the people and the country’s financial system. This article delves into the root causes of the drop and analyzes the impacts of this event on the Pakistani economy.
What led to the drop-in foreign exchange rates?
Several factors have contributed to the drop-in foreign exchange rates. Firstly, Pakistan’s current account deficit has been on the rise, leading to a decline in foreign currency reserves. Additionally, a decrease in exports and a rise in imports have also hurt the economy. The COVID-19 pandemic has also played a part in exacerbating the situation, leading to a significant decrease in remittances and a decrease in tourism revenue.
The impact on the Pakistani economy
The drop in foreign exchange rates has had a profound impact on the Pakistani economy. The depreciation of the Pakistani rupee has led to an increase in inflation, making it difficult for the common man to meet his daily expenses. The cost of imported goods has risen, leading to an increase in the cost of living. This development has put a strain on the average Pakistani’s purchasing power, resulting in a decrease in their standard of living.
Additionally, the drop in foreign exchange rates has also had a significant impact on businesses in Pakistan. It has become more expensive to import raw materials and machinery, making it difficult for businesses to operate. Moreover, foreign investors have become hesitant to invest in the Pakistani economy due to the uncertainty surrounding the foreign exchange rates.
Countries in a similar situation
It is important to note that, according to World Bank statistics, Pakistan and the following nations are in a similar position in terms of their foreign exchange reserves. The nations that are closest to Pakistan in this regard are listed below.
Myanmar
Ghana
Sri Lanka
Zambia
To determine the relative parallels with Pakistan, it would be worthwhile to investigate the overall political and economic conditions in these nations. Here, we’ll examine each nation’s political and economic climate individually.
Myanmar
The economy of Myanmar is still characterized by high volatility and instability. Conflict, power outages, trade, and foreign exchange restrictions, shortages of essential commodities, and regularly changing laws and regulations have all interfered with business operations. Domestic demand is still poor, notwithstanding the resilience of certain enterprises.
Inflation grew to approximately 20% in mid-2022 as a result of the weakening kyat, rising international prices, and persistent logistics challenges. This has subsequently made household financial problems worse and had an impact on the economy.
The combined political and economic effects of recent shocks continue to strain household earnings. In a poll performed in July and August 2022 by the International Food Policy Research Institute (IFPRI), over half of all families reported incurring income losses compared to the prior year and reduced their food and non-food consumption as a result.
Some economic measures are inconsistent. Transportation has returned to pre-COVID levels, construction is still going strong, and energy output has remained constant. The trade has been rather resilient. Yet, it appears that industrial production and new orders have decreased since July. There have been indications of a pick-up in domestic investment during the last six months, but international investment is still poor.
Businesses stated that they were operating at 66 percent of capacity on average in December 2022, according to the World Bank company survey, which is similar to March levels but an improvement over June and September. The percentage of agricultural businesses citing war as their biggest difficulty decreased significantly, while the percentage of businesses from all industries saying there were no operational challenges rose to about 40%.
The frequency of rule and regulatory changes has increased, which has led to greater uncertainty over imports and access to foreign currency, decreased trust in payment systems, and slowed down the customs clearing process.
Nonetheless, some companies are figuring out how to deal with difficult circumstances. Some businesses profit from having access to advantageous exchange rates and being free from certain rules. Some have shifted their payment and trade practices to unofficial channels. Businesses that depend on export demand, which has been quite strong, often perform better than those that focus primarily on the domestic market.
The GDP growth estimate of 3% for the year ending September 2023 suggests that the per capita GDP will remain around 13% lower than it was in 2019, demonstrating the lingering effects of recent shocks to both supply and demand. In contrast to the majority of East Asia and the Pacific, where activity has not returned to pre-pandemic levels. Without other shocks, the economy is projected to keep growing modestly through 2023, but at rates far slower than those seen before the epidemic.
While domestic consumption will continue to be poor and there is likely to be no improvement in overseas tourism, the services sector is predicted to have moderate growth over the upcoming year as inflationary pressures relax. Due to poor domestic demand and declining export demand, the growth of the industrial sector is anticipated to decline. The agricultural sector is anticipated to rebound in light of recent indications of agricultural output resilience. Pressure on major input prices is anticipated to reduce through 2023, and exports of rice, pulses, and maize are anticipated to continue to grow quite well.
Ghana
Ghana’s borders with Togo, Cote d’Ivoire, and Burkina Faso are on the Atlantic Ocean. There are around 29.6 million people there (2018). It has made significant progress towards democracy over the past 20 years under a multi-party system, and its independent judiciary has gained the confidence of the populace. Ghana routinely ranks among the top three nations in Africa for press and speech freedom.
The Supreme Court’s decision to reject the opposition’s election appeal resulted in President Nana Akufo-reelection, Addo’s giving the ruling New Patriotic Party a second term. The success of President Akufo-second Addo’s term will depend on his capacity to carry out his campaign commitments by reaching an understanding with the opposition and implementing economic diversification in the face of Ghana’s mounting debt and economic hardships.
Recent Economic Developments and Outlook
The COVID-19 epidemic, the March 2020 shutdown, and a dramatic decrease in commodities exports all put an end to Ghana’s strong development (7 percent per year in 2017–19). The decline in the economy has a significant effect on households. According to estimates, the poverty rate grew slightly from 25 percent in 2019 to 25.5 percent in 2020. Due to the robust agriculture and services industries, growth increased to 5.4 percent in 2021 after dropping to 0.5 percent in 2020. The character of Ghana’s recovery was mostly labor-intensive and inclusive, with minimal support from the extractive industry.
The global GDP increased by 3.3 percent in the first quarter of 2022 as opposed to 3.6 percent in the corresponding quarter of 2021. Moreover, non-oil growth decreased dramatically (from 5.3 to 3.7 percent), which was caused by a slowdown in both services and agriculture.
Fiscal strains are still quite severe. The budget deficit for the first half of 2022 was 5.6 percent of GDP, far higher than the 3.9 percent projection. Due to the flagship e-delayed levy’s introduction and difficult deployment, revenues underperformed. By the end of June 2022, interest payments had increased to 54.4 percent of first-half income and state debt had grown to 78.3 percent of GDP. With escalating macroeconomic imbalances, the government and IMF started talking about a potential program in July 2022.
From 12.6 percent at the end of 2021, inflation increased to 31.7 percent y-o-y (an 18-year high) in July 2022. The impact of rising global commodity costs has been exacerbated by the loss of the cedi, which has already lost 24 percent of its value against the dollar in 2022 (Ghana buys 40 percent of its fertilizers from Russia) (according to the Bank of Ghana data). Both the government and the Bank of Ghana (BoG) have made efforts to reduce inflationary expectations by reducing spending, increasing the monetary policy rate (MPR) to 22%, and increasing the main reserve requirements for banks from 12 to 15%.
The banking industry has continued to function well despite these macroeconomic obstacles. The ratio of non-performing loans decreased from 17 percent in June 2021 to 14.1 percent in June 2022. Nonetheless, loans to the private sector only expanded extremely modestly in the first half of 2022. (at 3 percent).
Due to significant oil and gold revenues, the trade balance was in surplus as of the end of June 2022. Nevertheless, the entire current account reported a deficit of 1.5 percent of GDP as a result of investment income outflows and net services account payments. As a result, in the first half of 2022, the stock of gross international reserves decreased by US$2 billion, to 3.4 months of imports.
High inflation and currency devaluation have increased living expenses, particularly for food. Budgets for households have been significantly strained as a result, especially those of the poor who spend more than half of their income on food. Prices for fertilizer and other inputs have increased, which has also had an impact on farmers in rural areas.
Outlook
As a result of macroeconomic volatility and corrective policy actions that reduce aggregate demand, GDP growth is predicted to drop to 3.5 percent in 2022 and an average of 3.3 percent during 2022–2024. Monetary and fiscal tightening will amplify the deteriorating effects of high inflation and high-interest rates on private consumption and investment. On the supply side, in 2023, industrial output is projected to grow by 2.4 percent (compared to a projected 3.8 percent in 2022), as the oil and gas sector slowly recovers from the technical difficulties experienced in the previous two years; agriculture is expected to grow at a rate of 2.2 percent due to high input prices and specific issues with cocoa plants; and services are expected to grow at a rate of 2.7 percent due to high domestic inflation that is eroding consumer purchasing power.
In 2023 and beyond, the budget deficit is expected to be significant (9.2 percent of GDP). Indeed, it is anticipated that changes would happen gradually as a result of contributions from revenues and expenses.
Risks and Challenges
The primary threats to the forecast are the escalation of macroeconomic vulnerabilities, including the unanticipated realization of contingent liabilities in the energy and financial sectors, as well as the unmooring of inflationary expectations. Insufficient access to capital, significant interest rate rises, and additional currency depreciation might all pose threats to the sustainability of debt. The necessity to roll over a sizable amount of domestic debt will put pressure on already high domestic interest rates. Meeting these significant demands might constrain private sector investment and put the appetite for the sovereign debt of the local banking sector to the test.
Sri Lanka
When Sri Lanka failed to pay US$ 78 million in debt interest even after using a 30-day grace period in May 2022, it fell behind on its commitments to its creditors. The country’s overall foreign exchange receipts fell by 29% between 2019 and 20211, according to Sri Lanka’s foreign exchange profits. This loss happened as a result of a significant drop in both remittances (18%) and tourism (86%). As of June 30, 2022, the foreign exchange reserves were valued at US$ 1.7 billion, of which US$ 1.5 billion was held under a swap facility offered by the People’s Bank of China. Hence, Sri Lanka was classified as a defaulting nation by credit rating agencies. Due to a serious balance of payments issue and unmanageable debt, Sri Lanka is experiencing slow economic development.
The most recent South Asia Economic Focus and the Sri Lanka Development Update project a 9.2 percent real GDP decline in 2022 and a further 4.2 percent decline in 2023. Sri Lanka’s economic prognosis is significantly unclear due to the unstable political environment and the worsening imbalances in the fiscal, external, and financial sectors. High levels of uncertainty surround the economic prognosis, which is dependent on how well debt restructuring, fiscal reduction, and structural changes that promote growth are progressing. Even with tighter monetary policy, inflation is expected to remain high. Due to consolidation measures, the fiscal deficit is anticipated to steadily decrease over the medium term. Due to import compression, the current account deficit is anticipated to decrease. To address the external financial shortfall in 2023 and beyond, further resources will be required. In the upcoming years, poverty is anticipated to stay above the 25 percent mark.
A sluggish debt restructuring procedure, minimal outside financial help, and a protracted recovery from the crisis’s lasting consequences are some of the major downside concerns. To reduce inflationary pressures, tougher monetary policy must go hand in hand with fiscal austerity. To go back to a level of debt that is manageable, significant debt restructuring is required. With its substantial exposure to the public sector, the financial industry needs to be controlled carefully. The required macroeconomic adjustments could initially harm growth and poverty, but they will address the imbalances, assist in regaining access to global financial markets, and provide the groundwork for long-term, sustainable progress. During the adjustment, it is crucial to reduce the effects on the weak and impoverished. It will be necessary to increase employment in industry and services and to regain the real worth of income to reduce poverty. On the plus side, a trustworthy reform plan backed by funding from foreign partners might boost trust and draw in new investments.
Background
Before the COVID-19 outbreak, Sri Lanka’s economy was already beginning to exhibit indications of decline. In the previous five years, both growth and the fight against poverty had stalled. External imbalances had been exacerbated by a managed currency rate, a bad investment environment, periods of lax monetary policy, and a restrictive trade regime. Tax cuts in 2019 together with ongoing fiscal inequalities, which are caused mainly by inadequate revenue collections, have increased fiscal deficits, increased gross financing requirements, and accelerated the buildup of unsustainable debt.
2020 saw Sri Lanka lose access to global financial markets as a result of credit rating reductions. Without access to the market, Sri Lanka continues to pay for imports and repay its foreign debt with the help of state reserves and loans from the banking industry. Except for a currency transaction for US$1.5 billion with China, official reserves decreased from US$7.6 billion in 2019 to less than US$400 million in June 2022. The banking system’s net foreign assets also decreased, reaching US$ -5.9 billion in June 2022. With shortages of gasoline, medications, cooking gas, and other essential inputs for economic activity, this acute FX liquidity restriction has been felt across the economy, especially since the second quarter of 2022. Sri Lanka declared in April 2022 that it would suspend paying its external debts due to low reserves, and it later named financial and legal advisers to help with debt restructuring.
In July 2022, a new president was chosen amidst widespread popular demonstrations. Nonetheless, because of the ongoing economic crisis, political tensions are still high.
Recent developments
In the first half of 2022, the GDP shrank by 4.8% annually. Due to input shortages and supply chain interruptions, all important industries experienced contraction. The purchasing managers’ indexes and other high-frequency indicators point to ongoing stress after the first six months.
In August 2022, year-over-year inflation hit an all-time high of 64.3 percent, partly as a result of significant food inflation of 93.7 percent. This reflects the effects of the monetization of the budget deficit, rising global commodity prices, and currency depreciation. Domestic food supply, agricultural revenues, and food security have all been impacted by the prohibition on chemical fertilizers in 2021 and its corresponding effect on crop yields. To combat inflation, the central bank increased policy rates by a total of 950 basis points between January and July 2022.
Due to the economy’s forecast downturn, poverty is predicted to have grown in 2022. Due to food inflation, job losses, a shortage of fertilizer, and a decline in remittances, poorer households are the most severely affected. Although social assistance helps in certain ways, it is insufficient in light of the significant actual income losses. In the first half of 2022, the goods trade deficit decreased by 18.6% year over year as exports, notably textiles, expanded faster than imports, which were mostly supported by Indian financial assistance totaling about US$3.8 billion. The current account deficit is anticipated to have increased during this time due to decreased remittances and few tourism receipts. The Sri Lankan Rupee (LKR) was floated by the central bank of Sri Lanka in March. When the currency declined by 78 percent after the flotation, the float was managed in May. Due to poor market trust, it has been difficult to transfer export revenues and remittances to Sri Lanka through official channels despite necessary repatriation and conversion requirements.
Many revenue initiatives, such as a one-time tax levied on major corporations, helped lower the primary deficit in the first four months of 2022 even while expenditures rose due to increased support offered to public employees, retirees, and recipients of social protection. Regarding the growing interest expense, the total deficit was predominantly covered by the central bank and remained largely constant. The administration hiked the value-added tax rate from 8 to 15 percent and proposed new tax laws in May and via the interim budget in August to generate income.
How close is Pakistan to a situation like that of Sri Lanka?
It is worth noting that Pakistan has faced its own economic challenges in recent years, including a large current account deficit and a heavy external debt burden. In July 2019, the International Monetary Fund (IMF) approved a $6 billion bailout package for Pakistan to help address these issues. In exchange, Pakistan agreed to implement a series of economic reforms, including fiscal consolidation measures and structural reforms to improve the country’s competitiveness.
Since then, Pakistan has made progress on some of these reforms, including implementing a tax reform package and restructuring state-owned enterprises. However, the country’s economic situation remains challenging, and the COVID-19 pandemic has only added to the difficulties.
According to the World Bank, Pakistan’s economy contracted by 0.4% in 2020, and the country is expected to face ongoing economic challenges in the coming years. Inflation remains high, with an average rate of 8.9% in 2020, and the poverty rate is also expected to increase due to the pandemic.
While economic challenges can certainly contribute to social and political instability, it is important to note that Pakistan has not experienced a large-scale civil war like the one that occurred in Sri Lanka. The country remains relatively stable, with functioning democratic institutions and a government that is working to address its challenges.
In conclusion, while Pakistan faces significant economic challenges, it is not currently facing a situation similar to that of Sri Lanka. The country remains stable, with a democratic government and ongoing efforts to address its economic and social challenges.
Zambia
In the middle of Southern Africa, in a huge, landlocked, resource-rich nation with a sparsely inhabited territory, is Zambia. Eight nations (Angola, Botswana, the Democratic Republic of the Congo, Malawi, Mozambique, Namibia, Tanzania, and Zimbabwe) share its border and together they represent a larger market for its exports.
Zambia is one of the youngest countries in the world and is undergoing a significant demographic transformation. Its primarily urban population is anticipated to be 18.9 million as of 2021 and is expanding quickly (2.9% annually), increasing the chance that it will double in size roughly every 25 years. As its sizable young population reaches reproductive age, this tendency is anticipated to continue, increasing the need for jobs, healthcare, and other social services.
Political Context
In 1964, under Kenneth Kaunda’s leadership, Zambia became an independent nation. Zambia changed from being a long-running one-party state to a multi-party system in 1991. The country is regarded as stable and has elections every five years. Nine presidential elections have been conducted since the nation’s independence, and four different political parties have held the reins of power. They include the United National Independence Party (UNIP) from 1964 to 1991, the Patriotic Front (PF 2011–2021), the Movement for Multiparty Democracy (MMD 1996–2011), and the current United Party for National Development (UPND). After beating the Patriotic Front’s Edgar Lungu, the incumbent president at the time, President Hakainde Hichilema of the UPND was elected in August 2021. Zambia’s next presidential election will take place on August 12 of 2026.
Economic Outlook
After experiencing a 2.8% drop in 2020 due to the pandemic, Zambia’s economy recovered in 2021 with GDP expanding at a rate of 4.6%. High copper prices, post-election market optimism, and ongoing agricultural revival all contributed to the economy’s rebound. The economy has continued to grow over the first half of 2022. In 2022Q1, the GDP increased by 2.4% year over year, helped by a surge in services that countered reductions in manufacturing, mining, and agriculture. A significant trade surplus in the year’s first half has helped preserve a sizable current account surplus. In the same vein, despite a significant gain following the election, the kwacha exchange rate has been steady while being aided by a buoyant market environment and copper income. The macroeconomic environment, increasing power supply, and stable and predictable mining policy environments are all predicted to contribute to the GDP rising by 3.8% between 2022 and 2024. The realization of the macro-fiscal changes indicated in the government’s medium-term budget for 2023–25 is the foundation for this prognosis. These reforms seek to refocus expenditure (away from wasteful subsidies towards increased social spending) and bring government services closer to the communities to restore budgetary sustainability and credibility. The implementation of structural reforms aimed at removing market inefficiencies, ensuring financial sustainability in the energy sector (electricity and petroleum), boosting transparency, and combatting corruption would also be necessary to achieve this economic route. It also assumes an immediate and thorough debt restructuring in line with the G-20 Unified Framework for Debt Treatment.
Zambia (ZMB), Myanmar (MMR), Sri Lanka (LKA), Ghana (GHA), and Pakistan (PAK) are the nations that maintain a similar proportion of foreign exchange reserves in months of imports, according to the accompanying graphic. The nations with the largest amount of foreign currency reserves in months of imports are China (CHN) and India (IND).
Conclusion
Pakistan’s foreign exchange reserves are an important indicator of the country’s economic health and its ability to meet its international financial obligations. Pakistan’s foreign exchange reserves are indeed comparable to those of other developing countries such as Zambia, Sri Lanka, Myanmar, and Ghana.
Pakistan’s foreign exchange reserves held by the central bank rose by $66 million to $3.258 billion in the week ending Feb. 17, it said on Thursday, while its total liquid foreign reserves stood at $8.726 billion.
Pakistan, which is a $350 billion economy, is facing economic turmoil, with a balance of payment crisis and only enough foreign exchange reserves to cover three weeks of imports.
Islamabad is expecting external financing inflows after a deal with the International Monetary Fund (IMF) is finalized, something that is likely this month. However, it is worth noting that Pakistan has made efforts to increase its foreign exchange reserves in recent years. In addition to the IMF bailout package, the country has received financial assistance from other international partners, including China and Saudi Arabia.
In conclusion, while Pakistan’s foreign exchange reserves are relatively low compared to some other countries, the country has made efforts to increase its reserves and remains committed to addressing its economic challenges. It is important to look at a range of economic indicators when assessing the health of a country’s economy, rather than relying solely on one measure such as foreign exchange reserves.