Unwanted milestones

Updated September 06, 2013


OVER the past few months, Pakistan’s economy has crossed three unhappy milestones of sorts:

— The rupee finally crossed the 100 to a dollar mark, having lost over 10pc in its value since July 1, 2012.

— Bangladesh’s exports overtook Pakistan’s ($26.6bn versus $24.5bn).

— Debt servicing has become the biggest budget item, overtaking defence and development spending.

The underlying developments that have brought us here are not unrelated, and have been in the making for a long time. Hence, we should not be surprised. We should also not curse our stars that these events have occurred now.

As Pakistan has discovered, and India is discovering to its economic peril, when nations ignore fundamental structural reforms for too long, they become accident-prone. Festering issues left on the boil have now begun to unleash their toxic fumes: Karachi and Balochistan need serious attention, as do internal security threats in other parts of the country.

Immediate and far-reaching institutional reforms are the order of the day across the entire spectrum of the governance framework, including in civil service, police, tax administration, the overall public sector, energy, education, water security, etc.

Partly by bad design, and partly by default, the IMF programme is not going to address Pakistan’s structural issues — the latest programme in particular. The most the rather weak current arrangement will ensure is a series of minor “course corrections” for the economy, to avoid a mid-air collision before end-2014, the designated timeline for the US retreat from Afghanistan. It is not designed to take us to our promised destination. That is a job we will have to do ourselves.

The rupee: After years of speculation, and trepidation, regarding when the rupee will hit a century against the US dollar, the event itself was quite anticlimactic. When the rupee crossed the 100 to a dollar mark in the inter-bank market recently, it had been anticipated and forecast for so long that most people in the markets took it in their stride. In fact, those who had sold their rupee assets and moved big-time into the dollar in anticipation were even gleeful rather than sombre or downcast.

Unlike the dramatic falling-out-of-the-sky of the Indian rupee, which has lost 18pc of its value against the dollar since January, the Pakistani rupee’s flirtation with, and eventual move beyond, the 100 to a dollar barrier almost seemed like an airliner’s gentle glide path on “long finals”. (This is also borne out by the fact that in 2008, the balance of payments crisis unfolded over a few short months, with monthly foreign exchange reserve depletion averaging, at $900m, nearly twice the level in the current episode.)

Even though many of us have been taught to think of the exchange rate as “just another price”, the decline beyond 100 still left a lot of people with a sinking feeling. For one school of thought, the exchange rate is a reflection of the overall health of the economy, and in Pakistan’s current circumstances of capital flight of every kind, especially from Karachi, the rationalisation that the rupee’s slide will be good for our balance of payments and longer-term investment prospects may be overly simplistic and a touch too optimistic.

It has taken the Pakistani rupee 66 years to get here. But, as most readers would be aware, the rupee has really been on a slippery slope since the 1990s. From an exchange rate of Rs21.85 to a US dollar on July 1, 1990, the rupee has lost nearly 80pc of its value. In comparison, the Indian rupee has lost roughly 60pc of its value, and the Bangladeshi taka approximately 51pc over the same period.

The bulk of the precipitous erosion in the rupee’s value has occurred since mid-2008, with the currency losing roughly 40pc. The severe pressure on the rupee in 2008 (and continually since then) occurred due to a number of factors. Briefly, these included:

• A strong overvaluation of the rupee, brought on by the Musharraf government’s policy of keeping the exchange rate stable over a long period of time;

• Imports rising faster than exports due to the nature of policies pursued in the 2003-7 period;

• The “super spike” in international oil and commodity prices since 2006-07;

• A sharp fall in foreign direct investment (FDI) from its peak;

• A steep reduction in net transfers from external sources;

• Persistent capital flight;

• A loss of export markets due to Pakistan’s internal security and energy situation.

Going forward, the fall in the rupee’s value can be arrested in the medium term by undertaking meaningful economic reforms which will improve our external competitiveness. A number of concomitant measures will be needed to stabilise the external payments position.

Reducing dependence on expensive energy imports by rationalising the fuel mix will be increasingly important in keeping pressure on the balance of payments in check. (It will also be a critical element in improving the competitiveness of Pakistan’s exports.) Agricultural productivity will play a crucial role as well, both in reducing the bloated food import bill and in generating exportable surpluses.

Any improvement in Karachi’s plight and in the overall investment environment will help in arresting capital flight as well as attracting foreign interest and investment at a later stage. A resumption of the government’s privatisation programme could also afford an opportunity to kick-start FDI, which could act as a catalyst for more potential investment from abroad.

As the battering of India’s currency demonstrates, there is no escape from pursuing a course of serious, credible and meaningful institutional as well as structural reforms.

The writer is a former economic adviser to the government, and currently heads a macroeconomic consultancy based in Islamabad.