Jameel Ahmad - AMONG emerging markets, Pakistan stands out as having one big advantage; it is building its foreign currency reserves to higher levels. Currently its reserves stand at close to $21 billion, ranking it at number 55 out of 187 countries worldwide. For comparison’s sake, emerging market Malaysia has $9.6 billion in reserves, whereas another emerging market, Indonesia, has reserves of $10.8 billion.

There are three main reasons why this gives Pakistan a good advantage against competing emerging markets;

* US interest rates: forex reserves act as a buffer when the US raises interest rates.

* National debt: FX savings act as a type of fail-safe mechanism when it comes to government debt and the ability to repay bonds.

* Investor confidence: foreign reserves act to reassure investors that the central bank and banking sector have ample resources for a rainy day.

The reserves owned by Pakistan are a result of the IMF’s economic advice to the government, and part of its structural development plan. Forex reserves held by the central and commercial banks are used to back up external and domestic debts.

The pros and cons of each of the above reasons provides some insight into Pakistan’s short-to-medium term economic prospects.

US Interest Rates

When interest rates go up in the US, financial resources tend to flow away from emerging market assets and towards USD-denominated assets. This can cause a knock-on effect to the wider economy, pressuring government debt, for example.

At 70 billion USD and 61 percent of GDP last count, Pakistan’s debt is a cause of concern to the IMF. The increasing level of foreign currency reserves is therefore a buffer against future US interest rate hikes and their potential effect on government debt and the risk of defaults.

In another scenario, if the Federal Reserve hikes the key US interest rates, the USD strengthens against its rivals, making commodity imports like oil more expensive relative to local currencies. Pakistan imports around 4.5 million barrels of crude oil per month, so any increase in the strength of the USD is a significant cost to consider. A deep foreign currency reserve can offset this risk to a degree.

Government Debt

In 2014, Pakistan successfully returned to the Islamic Bond market and its commitment to building its foreign currency reserves means that it qualifies for IBRD structural funding with favourable terms from the World Bank. Clearly, this helps move things forward in terms of development projects and external debt, but on the downside, at 61 percent of GDP, government debt is still moving into riskier territory.

The economy grew at the relatively healthy rate of 4.7 percent in 2015, so this is another reassuring factor meaning that the state will have income from taxes and sales in order to repay its bond issues.

Investor Confidence

Naturally, investors like stability and a sense that there is a balanced and purposeful monetary policy. Foreign currency reserves go a long way in providing this reassurance. Since 2007, the global economy has been in a recessionary cycle, and recovery is slow.

Uncertainty for emerging markets in the current global economy centres around several factors; including the Federal Reserve’s outlook on interest rate policy, and the linked issue of the US’ economic performance alongside slowing global growth and additional concerns over China facing weaker momentum.

Any signs of increased hawkishness from Janet Yellen are enough to make the emerging markets wary of what lies ahead when it comes to investment risks and rewards.

In 2015, Pakistan exported 3.7 billion USD worth of goods to the USA. While a strong US economy could mean a boost in demand for exports to that massive market, it could also have another effect; a shift in investment to USD-denominated assets. In the case that the US raises interest rates this year, a valid question for any local businesses might be; where should I invest my resources for the best ROI; in US Treasuries or in hiring more staff to develop my company?

In the latter, Pakistan’s economy would benefit from more employment. Obviously, the more attractive the local economy is, the better the chances are that local businesses will see fit to invest more in jobs and new projects. It’s only reasonable to assume that when local businesses see a deeper reserve of foreign currency and efforts by the government to manage national debt, the argument is more favourable for boosting local investment. –The author is the Vice President of Corporate Development and Chief Market Analyst at FXTM.