Revisiting exchange rate policy

Published October 26, 2015
'Weakening currency values against the dollar are failing to boost export performance.'—AFP/File
'Weakening currency values against the dollar are failing to boost export performance.'—AFP/File

CONVENTIONAL wisdom tells us that a national currency should be allowed to depreciate to an ‘effective’ market exchange rate to boost exports.

However, a recent related report in the Financial Times on Asia says “weakening currency values against the dollar are failing to boost export performance”.

Not very long ago, the eurozone did not leave the exchange rate option to individual member-countries to tackle external trade issues when national currencies were abolished without the corresponding fiscal integration within the union of independent republics.

China, probably the world’s largest economy when measured by purchasing power parity, restricts its national currency to a range-bound float.

Responding to the recent 2pc devaluation of the Chinese yuan, many Asian countries promptly brought down the value of their currencies in a bid to restore their competitive edge in the export markets. They have pinned their hopes on cuts in exchange rates to retain their share in a shrinking global market and amid tumbling commodity prices.

And the latest reports indicate that a strong dollar is now shedding some of its value owing to a drop in the US’s exports and with the Fed’s move to raise interest rates stalled by the yuan’s devaluation.

If the depreciation of a currency is some sort of an exception, it could be of some benefit, but if it is (with a little time lag) almost universally adopted by competitors, then its usefulness cannot be maximised.

In recent years, the Pakistani rupee has been depreciating by 8-10pc per annum against the dollar, but the pace has slowed down since Finance Minister Ishaq Dar started looking at the rising debt-servicing cost of a falling rupee in a heavily debt-dependent economy and its contribution to the unmanageable fiscal deficit.

The currency’s value is perhaps seen as a trade-off between exports and the fiscal deficit in the context of the unabated appetite for foreign debt. And the foreign exchange reserves are approaching the $20bn-mark, piled up to beat back any unusual speculative attack on the rupee.

In the developments narrated earlier, one may try to discover some method in the madness and the need to initiate some thinking to revisit the conventional wisdom.

While the volatility of market exchange rates may hurt many economies, the return of the fixed exchange rate parity — pegged to a volatile dollar (which is being gradually abandoned) — can be ruled out for reasons that led to the virtual demise of the fixed parity system.

The fixed parity ultimately and often resulted in big shocks to the economy, as Pakistan witnessed after a massive but much-delayed devaluation in the early 1970s as the import-substitution programme held sway.

Thus, the choice is restricted between a volatile free foreign exchange market and a managed one to keep a national currency as stable as possible, first because of the currency ‘war’ and secondly because, in the current sluggish international demand, not much can be done to boost exports. This was demonstrated by the yuan’s unexpected 2pc devaluation, with many nations following suit.

The value of any currency should reflect the fundamentals of the economy and should not be determined by a volatile exchange market alone.

This can be done by a managed float if the economic development strategy is anchored on the twin objectives of boosting exports as well as import-substitution. This will boost dollar earnings while conserving greenbacks at the same time.

And efforts must be stepped up to increase productivity in the export-oriented industries to make goods globally competitive both quality- and price-wise, rather than resorting to continuing currency depreciation for short-term gains.

For this to happen, the internal barriers to domestic trade, particularly at the district level, must be expeditiously removed for the national market to expand and prosper. And this needs to be combined with a restrictive foreign trade policy in selected areas where temporarily needed.

But the underlying idea should be to forge economic and trade relations on the basis of self-reliance and sovereign decision-making. Conventional wisdom is losing its relevance in a fast-changing global environment.

Published in Dawn, Business & Finance weekly, October 26th , 2015

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