WITH the most recent round of depreciation in the exchange rate, anxiety is mounting in the business community regarding the direction the economy is taking.

Most specifically, the one question people are now increasingly asking themselves, and each other, is where does this all end? Where is the exchange rate going to settle before 2018 finishes? All the answers to this crucial question are speculative at the moment, mainly because the underlying fundamentals themselves are changing rapidly, and the policy environment is marred by deep uncertainty.

The question is important because a significant amount of Pakistan’s exports use imported inputs, so if the price of these inputs rises so does the cost of the final product, thereby eating into whatever gains might accrue from the exchange rate depreciation.

Also, with every depreciation the price of energy rises since most fuels in Pakistan are imported. The recent hike in petroleum prices was attributed largely to the effects of the exchange rate rather than any hike in international oil prices, or to a raise in the rate of taxation for oil products. This has cascading inflationary consequences for the economy, which eats away whatever income gains people might have experienced during the couple of years of real sector growth.

Yet it is necessary. The currency depreciations by themselves may not be the solution to the external sector deficits, but they are a necessary precondition. The economy is currently burning around $1.2 billion of foreign exchange reserves every month, and given the size of the current account deficit and minus the short-term debt obligations that need to be met in the near future, this leaves barely enough for two months of imports.

Without a depreciation, levels of aggregate demand (especially for imported consumer goods) will remain unsustainably high, and the interbank market will need to be resupplied with dollar liquidity at regular intervals, through whatever means. With persistent shortages of foreign exchange in the interbank market, there is little else for the policymakers to do as a starting point other than get the price of the currency (the exchange rate) to reflect the fundamentals.

So where is all this going? It is no longer enough to hear that soon Pakistan will return to the International Monetary Fund, as caretaker Finance Minister Shamshad Akhtar all but said on her recent visit to Karachi. It is now important to know what that entails: a sharp reduction in aggregate demand and government expenditures, mid-year revenue measures, continuing depreciation of the currency, high inflation, higher interest rates.

All of these are now around the corner, and their cumulative impact is a sharp deceleration in growth. There is a lot the country needs to be prepared for if the situation on the external front is to be stabilised, and the time for that preparation to begin is now.

Published in Dawn, July 18th, 2018