Beyond the surface: Analysing SBP’s 30-month foreign reserves high

Pakistan’s foreign currency reserves have risen to $15.98 billion, of which $5.28 billion are held by commercial banks and $10.7 billion by the State Bank of Pakistan (SBP). This is the highest level of reserves in 30 months achieved via the inflow of the IMF loan: A sign of short-term stability.

Pakistan’s economic woes seem to be coming to a close with the upcoming Shanghai Cooperation Organization (SCO) summit in Islamabad, which begins October 16-17.

Foreign investments, including possible multi-billion dollar settlements from Saudi Arabia in the Reko Diq mining operation and loans for the ML-1 railway project, are expected to come to Pakistan. These funds are expected to immediately give relief to the economy but will also alter the value of the PKR.

It is possible that the foreign investment funds will increase the value of the PKR. This happens because when foreign funds arrive, they have to be converted into PKR before they are to be invested in local projects. As a result, the demand for PKR shoots up and the value of the PKR goes up. However, this appreciation is usually short-lived. Once the foreign funded projects are completed, the PKR tends to lose value again.

This historical pattern is linked to Pakistan’s huge trade deficit, which was $24.09 billion for just the fiscal year 2023-24 alone. This is due to Pakistan importing much more than it exports.

The imports that exceed exports are responsible for the outflow of foreign reserves which causes the PKR to depreciate.

Historically, to prevent the PKR from depreciating too much, the SBP has come in and started selling off foreign currency reserves to support the value of the PKR when it starts to depreciate. However, the sale of reserves is not a viable option to stabilize the PKR value in the long term as Pakistan runs a persistent trade deficit.

The more PKR the SBP buys, to artificially increase the value of the PKR, the more it depletes its reserves. Without any rise in the inflow of foreign currency from exports, this practice of artificially propping up the PKR is not sustainable.

The recent rise in reserves and the temporary boost from the SCO summit may give a sense of stability, but they don’t address the core underlying economic problems. Structural changes in exports and imports will help the rupee to remain under pressure unless the trade deficit is curbed.

While the SBP interventions may provide immediate relief, they only treat the symptoms, not the cause. To achieve true economic stability, the government needs to enforce reforms. Reducing the trade deficit by increasing exports to build sustainable foreign reserves is the need of the hour for Pakistan.

While the 30 month foreign reserves high is a reprieve for the state bank, it’s just that: A reprieve. The real question, though, is whether Pakistan will be able to grow when world leaders leave Islamabad after the conclusion of the SCO.