The government devalued the rupee by almost 8 per cent against the dollar on 22 October and announced plans to slash spending and raise taxes to narrow the budget deficit by Rs 40,000 million – almost $995 million at the new exchange rate. The moves come ahead of a visit by an IMF team on 24 October to carry out an economic review.
The State Bank of Pakistan (SBP – central bank) vigorously defended the new central rate of $1=Rs 40.22 saying it was designed to encourage foreign remittances and boost foreign currency deposits. SBP governor Muhammad Yaqub says the devaluation has the blessing of the IMF, which has withheld disbursements of a $600 million standby loan that were due in June and September. ‘The IMF has accepted it [the package] as the basis to restore the suspended standby arrangement and it may in the long run lay the foundation of a new ESAF [enhanced structural arrangement facility] arrangement, probably beginning in the next fiscal year,’ he says.
Yaqub also announced a new budget package designed to cut the deficit in 1996/97 to 4 per cent of gross domestic product (GDP), in line with IMF demands. Yaqub says that Rs 20,000 million- 21,000 million ($497 million-522 million) would be slashed from ‘less essential’ development expenditure, while Rs 6,000 million-7,000 million ($149 million-174 million) would be cut from current spending. A further Rs 13,000 million ($323 million) will be raised from additional taxes. Yaqub also announced an immediate 10 per cent rise in oil product prices, a move critics fear will push up inflation.
The new measures, though fiercely criticised by opposition parties, have been widely expected in business circles as the government has been under intense pressure to stem the fall in foreign currency reserves which currently stand at $756 million, equivalent to about four weeks of imports. SBP also raised its repurchase discount rate to 20 per cent a year from 17 per cent on 22 October to attract a fresh inflow of currency to replenish reserves.