KARACHI: The Pakistani rupee (PKR) has depreciated by 3% against the US dollar (USD) in the interbank market and by 4.5% in the open market since the end of June, when the International Monetary Fund (IMF) approved a $3 billion Stand-By Arrangement (SBA) for Pakistan to support its economic stabilization program1

The gap between the open market and interbank rates has widened to 3%, which may indicate further downward pressure on the PKR, as the IMF has recommended a maximum 1.25% gap in its recent report2.

The PKR movement has significant implications for Pakistan’s inflation, as the country is a net importer and has a large share of its consumer price index (CPI) basket exposed to USD-based pricing. According to the Pakistan Bureau of Statistics, the CPI basket comprises of 12 major groups, of which food and non-alcoholic beverages, transport, housing, water, electricity, gas and other fuels account for about 79% of the weight3. These groups are directly or indirectly affected by the exchange rate and the international oil price, which have both increased sharply in recent months.

The global oil price has risen by about 15% in the last month, driven by supply disruptions and geopolitical tensions. This has led to an increase of about Rs38/ltr (15%) in domestic petroleum product prices, which are adjusted monthly by the government. The higher oil price also affects the cost of imported food items, such as sugar, pulses, vegetable ghee and cooking oil, which contribute at least 2% to the CPI basket. Moreover, other segments related to food, such as ready-made food, are also impacted by higher transport and energy costs, adding another 5% to the CPI basket.

The PKR depreciation also erodes the purchasing power of consumers and increases the cost of imported raw materials and intermediate goods for domestic producers. This creates inflationary pressures across various sectors of the economy. The PKR depreciation also increases the debt servicing burden for the government and the private sector, as a large portion of their external debt is denominated in USD.

The inflation outlook for Pakistan is therefore challenging, as the country faces both external and domestic shocks. The CPI inflation rate reached 8.89% in June 2023, up from 8.34% in May4. The average inflation rate for July-June (2018-19) was 7.34%, well above the target of 6% set by the State Bank of Pakistan (SBP)5. The SBP has raised its policy rate by 650 basis points since January 2023 to 22%, in an attempt to curb inflationary expectations and restore macroeconomic stability6.

However, some analysts believe that further monetary tightening may be needed, as the 12-month forward CPI estimates remain above 22%, according to a recent report by Topline Securities7. The report also presents sensitivities of higher price increases for import-related items and compounding impact on food and transport segments due to PKR depreciation and oil price hike. The report warns that any deviation in these estimates may change the course of market expectations of a halt or continuation of the monetary tightening cycle.

The SBP is expected to announce its next monetary policy decision in September 2023. The SBP will have to balance between supporting economic growth and maintaining price stability, while taking into account the external and fiscal challenges faced by Pakistan. The successful implementation of the IMF-supported program will be crucial for restoring confidence and attracting foreign inflows, which will help ease the pressure on the PKR and improve the external balance.