THE petrol price adjustment made by the present government, and that was part of the IMF conditions agreed to by the previous government, attracted an immediate response in the foreign exchange market.
Consistent policies, and not politics, help the dollar behave, as the former finance minister indicated a few days ago, when he asserted the coalition government was incapable of controlling the nominal exchange rate.
Under the PML-N in June 2013, the nominal exchange rate was Rs101 per dollar, whereas during the recent political turmoil it reached Rs202 — a cent per cent increase over nearly a decade that featured the PML-N, caretakers, the PTI, and now a PML-N-led coalition government.
The rupee depreciated by 10pc annually. From June 2013 to August 2017, under the PML-N government, the rupee depreciated from 101.7 to 105.3 or by 3.5pc. From August 2017 to August 2018, before the PTI assumed power, the rate was Rs124 to a dollar, a depreciation of almost 19pc. Under the PTI, from August 2018 to April 2022, the rupee depreciated 47pc, with the dollar rising from Rs124 to Rs182. In April-May, the dollar appreciated by 20pc.
Thus, the market responded fairly well despite political uncertainty as the coalition government did not intervene in the market.
The former finance minister presented a low value of Real Effective Exchange Rate (REER) as an outcome of his good policy. A high REER value means an overvalued currency in comparison to trading partners’ currency. A low REER is a positive policy option for countries with huge export surpluses but import-dependent countries try to have artificially overvalued currencies.
During the PTI’s tenure, a low REER was the preferred policy to increase exports. The day the PTI government left, the REER was Rs99. A glance at Pakistan’s trade account shows that for exports, we have to import essential materials, for example chemicals, first. In this scenario, a higher REER (overvaluation of currency) was previously accepted as a policy choice to have cheaper imports rather than cheaper exports. As a result of overvaluation, we have cheaper imports for the urban middle class and traders make money without the hassle of production.
Import-bias policies have adversely affected competition. Unfortunately, the PTI government preferred cheap exports for more earnings. But these increased sluggishly in contrast to imports which rose rapidly. Sometimes China’s devaluation against the dollar was given as an argument for export success, without understanding that we do not have anything except conventional items to export. Even a low REER cannot help exports to grow at a faster rate than imports.
Depreciation is now an issue of national pride. TV anchors hysterically announce that the rupee has fallen so low that it has crossed all limits of civility and, if not controlled, the events in Sri Lanka will be repeated here. People tend to think that democracy depends on a stable rupee, that polls are the only solution and that the currency will get stronger just after the election. The salaried class and unemployed youth worry about the eroding value of the currency that makes imports expensive and causes inflation. As if the exchange rate crisis were not enough, industry has to deal with expensive imports, increased costs of electricity and outages, and expectations of high inflation.
Economists tend to base their analysis on the long-term movement of the rupee dollar parity.
Economists tend to base their analysis on the long-term movement of the rupee dollar parity —and not an artificially stable exchange rate. The rupee depreciates because people demand more dollars. The exchange rate is a byproduct of one’s ability to generate production, confidence in economic policies and herd behaviour. A falling rupee reflects inherent weaknesses in economic management, especially on the supply side.
Our ability to produce is low and we are losing competitiveness in global markets. Foreign investors don’t look at our market positively. In the past, economic managers opened the floodgates of capital account before liberalising trade. Later, these defunct economists drastically reduced tariff rates, but yet the country couldn’t attain the status of a globaliser. Exchange rate volatility is negatively related to the overall yield of bonds. It seems that the market forces are working at cross purposes.
During international financial crises, a high correlation is evident between the banking and currency crises. The interest rate is the channel left to the central bank to control in order to avoid financial crises. This channel is not working. Depreciation weakens the position of banks and creates a credit crunch. We don’t have domestic liabilities in foreign denominations but speculators make windfall gains.
Editorial: Currency concerns
Capital inflows increase steadily before a crisis and fall sharply when a crisis occurs. FDI declined from $2.6 billion to $1.8bn in 2020-21 and by 8.6pc in July-April 2021-22, with inflation hovering around 11pc. The recent gain in export earnings is not the result of product and location diversification, but currency depreciation and improvement in refunds. Surprisingly, expensive imports don’t reduce public or private consumption. There is a class that keeps buying imported goods for its own snobbish reasons.
The business-political nexus does not translate to formal lobbying in Pakistan but to being close to the corridors of power. A class of traders thriving on hoarding makes money and parks funds in stocks and real estate. It does not allow the government to bring informal businesses into the tax net.
Countries like Sri Lanka have seen a decline in GDP after the worst economic crises. But we have continuous exchange rate depreciation and increase in GDP at the same time. In stable times, GDP is negative and in times of volatility it goes up. Economic indicators are not overwhelmed by rupee depreciation. Our only worry is that the exchange rate will cause inflation and it has political implications — so avoid it as much as you can. The point of real concern only comes when we see depleting foreign exchange reserves, declining foreign capital inflows, heightened political risks, narrowing fiscal space and poor management — a great incentive for rent-seekers.
We need to discuss the direction of the economy and a sound macroeconomic policy framework, in particular, monetary and fiscal policies that are consistent with our choice of the exchange rate regime. Let economic decisions overrule political concerns in this poor, vulnerable and import-driven economy.
The writer is an economist.
Published in Dawn, June 2nd, 2022