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IN his budget speech, Finance Minister Ishaq Dar referred to a stable exchange rate as one of his government’s biggest achievements of the past year, referring to it as the “single most important indicator of economic stability”.
The argument is that the exchange rate determines so many other prices, especially oil, which cascades through the economy and impacts activity across the board. “A stable exchange rate is the lynchpin of a stable economy,” he continued.
It’s true that this government has stabilised the exchange rate, and brought it to a level nobody really thought possible. Many speculators were burned in the process. It’s also true that the reserves position has been stabilised, and the fears of a potential financial crisis that were so prominent the same time last year have now receded.
But a view that sees a stable exchange rate as “the lynchpin of a stable economy” could be more expensive to sustain than what the minister has bargained for. Let’s recall that the Musharraf government had also committed itself to a stable exchange rate, keeping the rupee steady at 60 to a dollar for almost half a decade.
The government should learn a lesson from the past before focusing excessively on a stable exchange rate.
However, the policy angered exporters, and consumed foreign exchange in growing quantities. Eventually, the government resorted to accommodating the exporters by doling out tax exemptions instead, and began to face tough choices when the inevitable balance of payments problems arose in 2006, and accelerated throughout 2007.
Something along those lines appears to already be under way. The present budget provides textile exporters with tax drawbacks in varying quantities provided they increase their export receipts by 10pc. Mark up on two key lending facilities for exporters — the export refinance rate and the long-term financing facility — have both been reduced by two percentage points.
Duty-free import of machinery will continue. In time look for these measures to widen, and more provisions offering tax and other benefits to exporters to start creeping in, partially as a consequence of the commitment to a stable exchange rate.
Nobody denies that a stable exchange rate brings some benefits, but it’s debatable whether it should be given the kind of importance the finance minister gave it in the budget speech. The problem with hanging your hat on the exchange rate is that it becomes a test case when the tide turns.
When that happened to the Musharraf government sometime in 2006 or 2007, the dilemma they faced was either to continue throwing scarce foreign exchange at maintaining the exchange rate, or admit defeat and allow a devaluation and thereby risk igniting speculative sentiment against the rupee.
The finance minister took some pride in managing the country’s debt profile. He says foreign borrowing has increased while domestic borrowing has gone down substantially. Getting government out of domestic debt markets was an important precondition for growth since government had been picking up all bank liquidity and then some, leaving nothing behind for private investors in a classic case of “crowding out”.
Not only that, the minister says replacing domestic with foreign borrowing improves the quality of the debt, since foreign loans have “low cost and longer tenors”, whereas the stock of domestic debt came at very high interest and was increasingly denominated in short tenors of three to six months only. He says the amount of money saved on debt servicing, as a result of this shift from domestic to foreign borrowing, is Rs24bn.
This is fair enough, but there is one drawback to foreign borrowing that he doesn’t mention: servicing of foreign loans is in foreign exchange, making continued reserve accumulation all the more crucial.
Some notable increases in expenditures include defence, which has enjoyed steady 10pc increases over the past five years at least, not including those portions of the defence outlays that are embedded in the civilian budget. This year, the hike in defence spending is a little larger still, more than Rs70bn, taking the total to Rs700bn. Greater transparency in the defence budget is a crucial element of strengthening democracy, as is greater parliamentary say in the framing of the threat assessment on which defence allocations are based.
A very large allocation has been made for a system of roads and highways in connection with the North-South corridor — Rs113bn for 74 projects to build roads and highways all the way from Karachi and Gwadar to Khunjerab. Big boosts have also been given to the railways — Rs77bn — as well as the National Income Support Programme, which includes the BISP and the Prime Minister’s Youth Programme, increased from Rs75bn to Rs118bn.
Subsidies have been brought down very optimistically. Last year, the government budgeted Rs165bn as subsidies for Wapda/Pepco, but ended up paying Rs245bn instead. This year they’ve budgeted Rs156bn, a sign they intend to get tough with the power bureaucracy, a signal further clarified by the appointment of Nargis Sethi as secretary , water and power. Things are about to get interesting in the power sector.
The budget is fairly typical of Mian Sahib: friendly to big business, stubbornly wedded to outdated notions, grandiose road-building projects passed off as infrastructure investment, and so on. A lot of visible activity is about to get under way, but how much it’ll all mean depends on the structural changes they’re able to implement.
The writer is a business journalist based in Karachi.
Twitter: @khurramhusain
Published in Dawn, June 5th, 2014
