The REER is approaching fair value
Pakistan’s real effective exchange rate (REER) – the value of the country’s currency against a basket of currencies of global trading partners – appreciated towards its fair value in November 2021 compared to October 2021.
“The REER Index was recorded at 98.5 in November 2021 from 96.4 in October 2021,” the State Bank of Pakistan (SBP) reported on its official Twitter account on Saturday.
“The RRSP index is considered to be at fair value when it is around 100,” said Sana Tawfik, economist at Arif Habib Limited (AHL), in an interview with The Express Tribune.
A REER below 100 is favorable to countries like Pakistan whose trade and current account deficits have widened to difficult levels and are leading to a reduction in the country’s foreign exchange reserves.
She explained that a slightly depreciated REER would help reduce the cost of exports, which was the need of the hour. On the other hand, the depreciated REER makes imports expensive.
Earlier, the government took a number of measures to increase exports and reduce imports in a bid to overcome the widening current account deficit and balance of international payments, she said.
However, “the REER had depreciated more than necessary and a recovery was due.”
Following the recovery of the REER (in November), Pakistani exports remained competitive but imports became expensive because the value was below 100, Tawfik said.
Unlike the REER rally in November, the Pakistani rupee has steadily depreciated against the US dollar.
“REER appreciation (depreciation) is sometimes confused with the concept of currency overvaluation (undervaluation), however, they are two separate concepts and cannot necessarily be interpreted in the same way,” the bank said. Central Pakistan while explaining the RRSP on its website.
The Rupee closed at Rs175.72 against the US Dollar on November 30, 2021 against Rs171.2 on October 29, 2021, according to central bank data.
In addition to the monetary value, the factors taken into account for the calculation of the RRSP value include the reading of inflation in the country and its trading partners and the value of the assets of two trading partners in a third country.
As a reminder, inflation hit a 21-month high of 11.5% in November due to a surge in the prices of global commodities that are imported to meet domestic demand.
“Currently, the State Bank of Pakistan uses the weight (of currencies) of 37 major trading partners and competitors of Pakistan for the calculation of the REER,” a central bank video implying explaining the concept, construction and l ‘interpretation.
“These weights not only represent bilateral trade volumes but also competition in third-party markets,” he said.
“For example, the weight of China in the index is 29.12%; it represents not only the volume of trade between Pakistan and China, but also the competition between Pakistani and Chinese companies in a third market such as the United States.
Experts said the rupee is expected to stabilize around 175-76 rupees against the US dollar before the resumption of the International Monetary Fund’s (IMF) $6 billion lending program by late January or early February 2022.
The resumption of the program by the board of directors of the IMF will be followed by the release of the next loan tranche of approximately 1 billion dollars. It will also open up other avenues for foreign exchange inflows, such as those from the World Bank and the Asian Development Bank (ADB).
On top of that, the expected reduction in the current account deficit to less than $1 billion a month in the coming months from the 40-month high of $1.9 billion in November would help stabilize the rupiah and keep the REER at its fair value, she said. .
“We (AHL) expect the rupee to hover around 178 rupees against the US dollar by the end of the current financial year (June 30, 2022) … and around 180 rupees by the end of December 2022” , she said.
Published in The Express Tribune, January 16and, 2022.