Investor Letter

Comments on Exchange
Rate Movement
July 27, 2022
 July 27, 2022

Dear Investor,

The Rupee has been under a lot of pressure lately as it has deprecated by 13% since Jun-22, trading above 235 in the
interbank market. The latest bout of volatility in PKR has emerged from the ongoing political upheaval which has
increased concerns on release of IMF tranche and thus overall balance of payment outlook for the year. While some
of the PKR depreciation is justified given the strengthening dollar and unfavorable inflation parity however a major
part of recent devaluation reflects political uncertainty and nervousness on release of IMF tranche. Clarity on IMF
tranche is likely next month where PKR may recover but short term pressure may persist.

Dollar Index march upward as Federal Reserve turns hawkish

The US dollar Index which measures the value of US dollar against a basket of currencies have been on an upward
trend since the start of the year. The global commodity super cycle has effected all economies and United States
also faces itself under inflationary pressure. In response to rising inflation the Federal Reserve have increased
interest rate to 1.75% from almost zero with additional hike of 75bps expected in July-22 Monetary policy. This has
led dollar to strengthen against other currencies including Pakistan Rupee.

US Dollar Index
110

105

100

95

90

85

80

Sources: Investing

Mismatch in Inflow-Outflows with limited SBP Intervention in Interbank

Commodity prices were already high as economies were reopening post Covid struggling with pent-up demand and
slower incoming supply chains. Escalation in Russia-Ukraine crises led to record increase in major commodities
including energy and food products. Pakistan being a net importer saw huge increase in trade deficit which along
with regular debt repayments depleted our foreign exchange reserves to USD 9.3bn which are hardly sufficient for
2 months of imports. With lower reserves SBP has limited room for intervention and has preferred to let the market
find the balance itself in the interim.

The impending IMF tranche which is expected in late August 2022 would help ease pressure and enable the country
to build reserves further with the support of bilateral and multilateral sources. Recent correction in major
commodity prices and slowdown in overall imports will help contain the current deficit which may come down to
near USD 6.5b for the current year down as against initial estimates of above USD 11bn.

Pakistan USD Reserves tend to build post entrance into IMF program
22,000 IMF IMF IMF
20,000
18,000
16,000
14,000
12,000
10,000
8,000
6,000
4,000
2,000

SBP Reserves USD/PKR

Sources: SBP, MCBAH

IMF Staff level agreement reached but concerns remain till release of tranche

The government has taken many of the difficult decision such as increasing petroleum, electricity and gas prices
(expected shortly) which were part of IMF prior conditions. These steps led to the successful Staff Level Agreement
with IMF. However, despite signing of Staff Level Agreement with IMF markets still remain jittery mainly on account
of political uncertainty. In addition to IMF disbursement, the country requires around USD 4 billion from friendly
countries to bridge the financing gap, and as per media reports a firm commitment is still required from friendly
countries before IMF tranche may be released. A stable political government is critical to gather such commitments
however ongoing political upheaval is making investors concerned on these flows.

Real Effective Exchange Rate indicates undervaluation

Real Effective Exchange Rate (REER) is a measure of the value of a currency against a weighted average of several
foreign currencies. While approach is an approximation and only a reference for long term valuation, balance of
foreign inflows and outflows determine the currency value in the short term. A REER below 100 means the country’s
exports are competitive, while imports are expensive. Pakistan REER clocked in at 93.6 in May 2022 as per the latest
SBP number. The REER has been on a downward trajectory after touching a high of 103 in April-21 as SBP has been
continuously allowing the currency to depreciate in response to the rising current account deficit. Incorporating the
subsequent inflation readings and currency devaluation we expect REER to have fallen below 90 in July-22.

We expect SBP to maintain REER below 100 this year given the challenging external outlook.
 Real Effective Exchange Rate – Current REER is estimated to be around 90

REER (LHS) USD/PKR

Sources: SBP, MCBAH (June-22 and July-22 number are estimated)

SBP indicating comfortable Balance of Payment Account

As media reports indicate, State Bank intervention in interbank has remained limited while daily inflow outflows
have resulted in pressure on exchange rate. To help improve confidence, SBP has recently held several interactions
with market sharing comfortable outlook on the external flows for the year. A liquidity and confidence crises
however usually requires strong intervention or tangible clarity to restore balance towards a reasonable range.
Incorporating a slowdown in CAD and other financial inflows shared by SBP our estimates indicate comfortable
position for the full year and reserves are likely to recover by year end.

Financing Requirement (USD Bn) Available Financing (USD Bn)

IMF borrowing
FDI, Portfolio & others

Multilateral and oil

financing Bonds & NPCs

Current Account Deficit

Expected rollovers from
bilateral, official sources
Bonds
IMF
Bilateral, official to be
rolled-over Multilateral, Paris club, Oil
facility & others

FY23 FY23
Sources: SBP, MCBAH
With REER hovering near 90 and overall balance of payment needs taken care of, Rupee may post some recovery
against the dollar only when after clarity on IMF tranche. We maintain our estimate of exchange rate in the range of
235-240 by fiscal year end. Going forward, trend in our export and remittances alongside trajectory of global
commodities prices would drive the Rupee value.
Disclaimer:

This publication is for informational purposes only and nothing herein should be construed as a solicitation, recommendation or an offer to buy or sell any security
including mutual fund. All investments in mutual funds and voluntary pension schemes are subject to market risks. The NAV based prices of units and any
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performance is not necessarily indicative of future results. Please read the Offering Document to understand the investment policies and the risks involved. The
publication is based on MCB-AH’s interpretation of the current economic and political environment. Investors are advised to make their own appraisal of the
investment opportunity and seek independent professional advice prior to making any investment or disinvestment decision. MCB-AH does not assume any
responsibility or liability in this behalf. This publication may contain forward-looking statements that are not historical in nature and which may be identified by the
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materially from those expressed. MCB-AH disclaims any obligation to update any forward-looking statements, whether as a result of new information, future events
or otherwise.