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Firefighting to shore up reserves

Updated October 09, 2017

The government has decided to impose five per cent to 25pc regulatory duty on about 250 non-essential imports as a way around the recent build-up of expectations of, and growing demands for, currency devaluation and to push back a looming currency crisis.

Simultaneously, the government also took a decision to hand out a few more concessions to exporters under the Rs180 billion package given in January this year and spread over a period of 18 months to June 2018.

By making imported old cars, fruit, handsets, garments, electronic goods, etc more expensive and encouraging exports, the government hopes to tackle the growing trade deficit that spiked to a record $33bn last fiscal year and stem the drawdown on the country’s fast-declining dollar reserves. But will it be able to do so?

By making imports more expensive and encouraging exports, the government hopes to tackle the growing trade deficit and stem the drawdown on the country’s fast-declining dollar reserves. But will it be able to do so?

“It is not the first time policymakers have tried to restrict luxury imports by making them more expensive and harder to bring in. Earlier in March, traders were asked to pay 100pc cash to cover their imports of what the government describes as non-essential items. The move didn’t yield the intended results, though. Instead, it encouraged smuggling and under-invoicing,” a leading trader from Lahore said on condition of anonymity.

“If the demand for something exists, it will eventually find its way to the market. Higher prices affect demand but only marginally. The markets and buyers always adjust to the changing realities quite quickly no matter what,” he chuckled.

The use of tariff barriers to discourage imports is being seen as a desperate attempt by the government to quash growing expectations of devaluation that have been building up for quite some time because of pressure on the country’s external sector.

Political uncertainty in the aftermath of former prime minister Nawaz Sharif’s disqualification by the apex court seems to have exacerbated the situation, with the government appearing to have lost its handle on the economy in an election-year, and with macroeconomic fundamentals slipping with the passage of time.

The central bank’s official dollar reserves dropped to $13.8bn on Sept 29 from $18.9bn a year ago.

Trade deficit has also soared to a record high mainly on the back of import of machinery and equipment for energy and transport projects under the $57bn China-Pakistan Economic Corridor initiative.

The current account deficit, which spiked to more than four per cent of the size of the economy to $12.1bn during the last financial year, has surged to $2.6bn in the first two months of the current fiscal to August.

“It is quite natural for the markets to build up expectations of rupee depreciation as the State Bank is running out of its foreign currency stocks with imports surging, and exports and workers’ remittances declining — or flattening at best,” argued a Lahore-based financial analyst.

“The government needs dollars to pay its bills, service its debt, shore up its reserves, restore confidence in the currency and quell expectations of a new round of currency devaluation,” he said. “At the moment, it doesn’t matter if we have to borrow more money to boost our foreign currency reserves in order to defend our financial stability, if the government wants to ward off rupee devaluation in the near election-year.”

A number of businessmen, and economic and financial analysts Dawn spoke to favoured a downward adjustment of the exchange rate to hold off a balance-of-payments crisis. “Our currency is overvalued and hurting our exports. Adjusting the exchange rate should boost our exports, help capital formation and bridge the widening current account gap in the long run,” a textile exporter contended.

Yet, not everyone advocating devaluation supports the demand for a weaker rupee unconditionally.

“It will be naive to expect devaluation of the rupee to take care of our current account woes. If the rupee value has to be adjusted it must be done as part of a combination of policy measures to narrow down the trade deficit through restrictions on imports and incentives for exports, as well as checks to stop smuggling and under-invoicing,” a head of research at a brokerage in Karachi insisted.

Another economic analyst, also from Karachi, questioned the demand for a weaker currency for boosting exports and eventually covering the current account hole.

“The currency depreciation doesn’t guarantee automatic increase in exports. In fact, you have got to have a stable currency to attract investment and grow exports as Bangladesh has done over the years. Devaluation will only fuel inflation and impoverish our people.

“The long-term solution to our balance-of-payments issue lies in offering incentives to our exports through tax reforms and reduction in energy prices in order to help them become competitive, curb non-essential imports without being over-protectionist, and attract investment in the manufacturing industry to produce surplus for exports and substitute imports,” he said.

Published in Dawn, The Business and Finance Weekly, October 9th, 2017