During the 1960s and early 1970s, Pakistan maintained a stable exchange rate of 4.7619 PKR per USD under the fixed or pegged exchange rate regime, ranking among the strongest currencies in South Asia. India, initially at the same rate, devalued to 7.5 by 1967 due to trade deficits. Bhutan and Maldives mirrored Pakistan’s rate, while Nepal’s weaker rate of 7.5 further depreciated to 10.125 by 1968. Sri Lanka devalued to 5.95 by 1968, and Afghanistan had the weakest currency, depreciating from 17.19 in 1960 to 38.69 by 1964. Pakistan’s exchange rate stability stood out amid regional economic challenges.

By 1990, Pakistan’s rupee ranked fourth at 21.71 PKR/USD, behind the Maldives, India, and Bhutan. Fast forward to 2024, Pakistan’s rupee depreciated sharply to 278.36 PKR/USD, ranking seventh out of eight countries in the region, with only Sri Lanka (292.51 LKR/USD) having a weaker currency. The Maldives maintained the strongest currency at 15.39 MVR/USD, followed by India and Bhutan, both at 85.30, and Afghanistan at 70.38. Bangladesh (119.01 BDT/USD) and Nepal (134.12 NPR/USD) also had relatively weaker currencies but were still stronger than Pakistan. This highlights Pakistan’s severe economic challenges, including inflation, rising debt, and trade imbalances.

The dramatic freefall of Pakistan’s currency over the past couple of years has become more alarming than ever. From 2012 to 2021, the exchange rate rose by 69.5 rupees, but in just two years between 2021 and 2024, it surged by 117.5 rupees, marking a staggering 72.1% depreciation. This sharp decline reflects severe exchange rate instability, which fuels economic uncertainty, drives inflation, widens trade deficits, and deters both foreign and domestic investment.

Exchange rate outlook bleak

The poor performance of Pakistan’s currency is primarily driven by rapidly depleting foreign exchange reserves, which currently stand at $15.95 billion. This amount is well below the three-month import threshold and significantly lower than Bangladesh’s $25.31 billion. Low reserves restrict the central bank’s ability to intervene in currency markets, leading to increased exchange rate instability.

The exchange rate outlook remains bleak as Pakistan faces substantial foreign debt repayments, which will heavily deplete the country’s foreign exchange reserves. In the fiscal year 2024-25, Pakistan is scheduled to repay $24.8 billion in foreign debt and interest, placing significant strain on already limited reserves. This substantial repayment obligation is expected to further weaken the exchange rate and amplify economic vulnerabilities.

Considering the critical role of foreign exchange reserves, it is essential to analyze the factors influencing them, their current levels, and their potential to positively impact the reserves.

Pakistan’s foreign exchange reserves hinge on stable inflows like exports, remittances, and FDI, while volatile sources like foreign aid and portfolio investments contribute less. Rising imports and foreign debt payments deplete reserves, highlighting the urgent need to address these critical factors to stabilize Pakistan’s economic foundation.

Pakistan’s exports of goods and services reached $38.903 billion in 2024, but their share of GDP has declined significantly from 17.3% in 1992 to just 10.5% in 2023. With an untapped export potential of $88.1 billion. Bridging this gap could significantly boost foreign exchange reserves, ultimately helping to stabilize the volatile foreign exchange market.

Remittances, second only to exports, are a crucial and stable source of Pakistan’s foreign reserves. As per the State Bank of Pakistan’s 2024 report, remittances reached $30.25 billion in FY-2024. However, an estimated $10.9 billion flowed through informal channels like hawala/hundi in 2018. Curbing these informal practices could inject over $10 billion annually into Pakistan’s foreign exchange reserves, significantly strengthening the economy.

In 2024, Pakistan received $1.9 billion in foreign direct investment (FDI), equivalent to just 0.6% of GDP, compared to $5.6 billion in 2007. With the potential to attract FDI up to 3% of GDP, or $9 billion. Pakistan can tap this potential by improving ease of doing business, ensuring political stability, and developing special economic zones.

High volume of imports

The composition of Pakistan’s imports of goods and services significantly strains foreign exchange reserves, as the high volume of imports continues to outpace exports. In FY-2024, the imports of goods reached $63.3 billion, nearly double the exports of goods, contributing to a substantial trade deficit.

Pakistan has the potential to add $70 billion to its foreign exchange reserves by adopting both short-term and long-term strategic measures. To achieve this, targeted steps are essential to enhance exports, remittances, and FDI, while effectively managing imports and foreign debt. Diversifying exports into sectors such as IT, engineering, and pharmaceuticals, combined with tax incentives and subsidized financing, can improve competitiveness. Encouraging formal remittance channels and actively engaging the diaspora can further boost inflows. Simplifying business processes, ensuring political stability, and establishing special economic zones (SEZs) with tax benefits will help attract substantial FDI.

Pakistan should prioritize local manufacturing to decrease reliance on imported goods and implement higher tariffs on luxury and non-essential items. These steps can effectively rationalize imports and narrow the trade deficit. To manage debt, Pakistan must negotiate favorable terms with creditors and restructure existing loans to alleviate repayment burdens. Moreover, broadening the tax base and enforcing fiscal discipline can minimize dependence on external borrowing, helping to stabilize foreign reserves and the exchange rate.

(The author is a Pakistan-based economist working as a research associate at the Centre of Economic Planning and Development (CEPD), Minhaj University Lahore, Pakistan. He also holds the position of Senior Lecturer at Minhaj University Lahore.  He can be reached at waqas.eco@mul.edu.pk / @waqasshair689)