|Impact Of Depreciating Rupee On Economy
Benefit to exporters of textiles and clothing will be short lived as the economy will face serious consequences
by SHABBIR H. KAZMI
Lately Pak Rupee touched a record low of 92.05 in the interbank bank market. The overall depreciation during the current financial year has been around 7% which is close to historic trend. Rupee depreciation is being attributed to a number of factors that include weak economic fundamentals, widening current account deficit and excessive government borrowing from the central bank, the factors that will continue to haunt in short to medium term. Added to this will be drying inflows and repayments to the International Monetary Fund (IMF) for the Standby Program signed in 2008. Pak-US relationship has dipped to the lowest ebb following attack on Pakistani checkpost leading to withholding of payment of US$800 million due under the Coalition Support Fund (CSF). Since elections are due shortly in both the countries, public sentiment driven approach will continue to remain in play. Therefore, the current stand-off between Pakistan and United States is likely to continue longer than expected. All these factors don't bode well for Pakistan.
Leading brokerage house, BMA Capital, has released a report examining the impact of depreciating Rupee. Though, the report is prepared with the objective to let the investors know the impact on listed companies belonging to various sectors, this also gives a fairly good idea of the impact on the consumers. The Government of Pakistan (GoP) has projected current account deficit of US$4.8 billion for FY13. Keeping in view repayment of US$2.6 billion to the IMF, foreign exchange reserves and exchange rate is expected to further aggravate. Although the economic scenario and consequent weakening of Rupee has negative repercussions for the economy, the sectors linked to Dollar are going to reap benefits, especially textile, independent power producers, exploration and production (E&P) and chemicals. While automobile and cement manufacturers would feel the heat, experts expect a neutral impact on fertiliser, OMC and refinery sectors.
Since Pakistan is heavily reliant on imported energy products and power generation is also skewed towards fossil oil, the overall impact will be negative for the consumers but bodes well for the energy chain. With petroleum product prices being linked to Dollar and guaranteed Dollar based IRR to power producers; the recent Rupee depreciation would directly augment the bottom-line of E&P and IPPs. With due share from additional flows coming online in FY13, leading E&P Pakistan Oil fields would benefit the most on account of its sales mix tilting towards oil. Oil & Gas Development Company (OGDC) and Pakistan Petroleum Limited (PPL) would also benefit from this development; however, due to higher gas sales the impact would be minimal on PPL.
Recently relieved from rising Japanese Yen, the automobile sector of Pakistan is set to take another hit. With cost structure being linked to both Yen and Dollar, any increase in both would adversely impact the margins of local auto assemblers. Moreover, amid concerns over duty relaxation on CBUs and government considering reducing duty on CKD, the ability to pass on cost would be limited.
Rupee depreciation would also bode negative for the cement sector because imported coal is being used. Though, the negative impact would be partially mitigated by cement exports for few big players, the net impact on the sector would still be negative.
OMCs & Refineries
Weakening of Rupee would benefit both OMCs and refineries in terms of higher absolute margins on products like furnace oil and higher absolute deemed duty respectively. However, as major portion of oil is imported, increase in exchange loss would largely offset this impact.
The local fertiliser sector (especially urea) would be one of the sectors which remain immune from exchange rate fluctuation. With no component being imported and no probability of its export, local fertiliser sector has received no major impact of recent Rupee depreciation. Though it would further augment the cost of imported urea, government would keep its import plan intact as part of populist measures. DAP and NP prices are directly linked to international prices, thus Rupee devaluation will lead to marginally higher DAP and consequently NP/NPK prices in the country. We do not see any negative impact on DAP trading margins for importers.
Report by InvestCap on outlook of textiles and clothing industry is also worth reading. Since Pakistan realised over 60% of its exports from textiles and clothing, many analysts are bullish but energy crisis is not likely to benefit the smaller exporters. However, only mega size companies having in-house power generation facilities and enjoying synergy are likely to benefit. Cotton prices have declined by 34%YoY during (July-March) period in the local and 26.4%YoY in the international markets. Recovery in margins is expected as cotton is available at low price coupled with revised international trading contracts. Global cotton production is estimated around 123 million bales, up 5.7%YoY. However, during FY13 cotton production is likely to plunge to 116 million bales which is same as FY11 production. Despite the estimated decline in production, nearly 67 million bales carry forward stock for FY13 will keep the price at modest level in the international markets.
During current financial year export of textiles and clothing declined by 10% to US$10 billion, mainly due to decline in quantity of different textile products but also because of reduction in cotton prices. With the major share in total textile export, cotton cloth segment exports declined by 15.4%YoY during July-April. Moreover, other textile segments knitwear, bedwear and readymade garments, were also down by 26%YoY, 20%YoY and 27%YoY respectively. At the best analysts expect FY12 export of textiles and clothing to be around US$12 billion against a target of US$16 billion. The ongoing energy crisis can be termed as 'mother of all evils'.
Over the years Pakistan's external debt has been increasing. On one hand it is eroding country's foreign exchange reserves and on the other hand, debt servicing is becoming unsustainable, depreciating Rupee adds to the woes. If inflows don't improve Pakistan will be forced to once again approach the lender of the last resort. If this becomes unavoidable further hike in electricity and gas tariffs, upward move in interest rate and withdrawal of some of the subsidies, will fuel inflation in the country. Pakistani exporters are already experiencing erosion in competitiveness and further hike in inflation rate will certainly bode well for them as well as for the country.