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The Dar-shaped curve

Updated July 13, 2017

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SOMETHING very important was said by Finance Minister Ishaq Dar in his angry remarks against the rupee’s depreciation last week that has passed unnoticed in the din of the Panama inquiry and the JIT report. The important blurb, spoken hastily in a moment of unguarded angst, went like this:

“Despite the eight to nine billion dollar current account deficit, if the reserves are still, by the grace of God, sitting at $21bn, it is because our team has performed that they are there. Therefore nobody should worry, or make a foundation out of the argument, so deliver an artificial jolt to Pakistan’s currency. If, praise be to God, there has been an automatic correction this morning, and if that had not happened, we were facing a public debt loss of Rs230bn.

“We have to look at our country, and see that we are in an expansionary phase, so the reactions [sic] we have to take under the circumstances, we have given a five to seven per cent duty drawback to exporters, which ought to be given, that is a targeted intervention. But we are moving into an expansionary economy, our growth rates are moving towards 6pc to 7pc, our economy is expanding, having crossed the $300bn mark for the first time, this is tantamount to giving it all a jolt!”

Now notice two things in what these words convey. First, a depreciation of 3.1 per cent means a “public debt loss of Rs230bn”, whatever that means (increased debt service obligations on external debt or increase in debt stock?). Second, the entire growth story that the minister never misses an opportunity to press upon us is at risk if there is to be a currency devaluation.

The rupee is being artificially propped up at its present level, and what happened last Wednesday was a small trailer of what is to come.

Having noted that, now consider the following: almost everybody in the financial markets as well as institutional voices like the IMF agree that the rupee is overvalued versus the dollar and a devaluation is now inevitable. When asked how far this devaluation must go, one gets different answers but I can no longer find someone who believes that the rupee is sitting at the right place versus the dollar.

Here is how the IMF put it in its last review of the facility that ended in 2016: “greater downward exchange rate flexibility would contribute to strengthening external buffers and supporting competitiveness, which has been affected by significant real effective exchange rate appreciation (about 17.5pc over the three-year programme period)”.

Translation: your currency is overvalued by 17.5pc. That was in October 2016. Since the beginning of the fiscal year, the current account deficit has more than doubled in only 11 months, which means the “external buffers” now need far greater strength than they did a year ago.

The balance of trade on goods and services has dropped by $6bn, a decline of almost one-third, meaning the competitiveness that is being eroded needs far more robust support than it did the same time last year. So the situation has deteriorated considerably from the time the 17.5pc figure was released by the IMF, and the longer one delays and drags out the inevitable, the greater the eventual “jolt” the economy will have to face.

Let’s ask this simple question: if a 3.1pc depreciation gives us a “public debt loss” of Rs230bn, what does a devaluation of 17.5pc give us? The numbers get quite large when you start to work along these lines.

This is what I call the Dar-shaped curve. What is real is called artificial, and what is artificial becomes real. What is structural and inevitable is ascribed to “miscommunication” between a few individuals and the consequence of “one man’s decision”, what is, in fact, a one-man decision becomes the normal and automatically discovered reality. The curve runs from the personal and the contingent, to the inevitable and structural, a little like a double helix, inverting meanings all along the way.

The rupee is, in fact, being artificially propped up at its present level, and what happened last Wednesday was a small trailer of what is to come if action is not taken quickly to deal with an external sector which is deteriorating at an accelerating pace. The depreciation of the rupee, which sent the minister into a frenzied tirade, was a bit like a bolt of lightning that fleetingly lights up the landscape before disappearing and leaving everything shrouded again in darkness.

Thanks to the minister’s own words, we can now agree that the consequences of a disorderly adjustment would be catastrophic to his growth story. In fact, given the kind of percentages we are talking about — 17.5 in October, much larger now, even larger down the road — there will be no option other than a massive and disorderly adjustment, meaning the growth story we are being told and living through and seeing unfold in packed shopping malls and a consumption spree that reminds us of the apogee years of the Musharraf regime, is living on borrowed time. It is destined for a crash.

But the government, hunkered down for a long-drawn fight in which there will be blood, is in no position to contemplate any action. It had a game plan drawn up long before the darkening clouds gathered over its head. And that game plan was to press ahead with the status quo till the elections, then let the interim government undertake the adjustment. That way they could say ‘while we were in power, things were good’ just like the Musharraf regime remnants said for a while after the great crash of 2008.

Fact of the matter is, Dar’s tale of growth is built on a lie. But the lie cannot last, and we now have a short glimpse of what the truth will look like when it arrives.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, July 13th, 2017