OUR economy is afflicted with several weaknesses one of which is Dutch disease. This economic malaise was first named by the Economist to describe the unfavourable impact in the Netherlands’ manufacturing sector — paradoxically, after the discovery and exploitation of huge gas reserves in the late 1950s.
This disease is a specific case of a broader problem — the natural resource curse. How did it come to afflict our economy even when we have so few natural resources? It is well known that our Sui gas reserves are depleting fast, as our unlit stoves show.
Dutch disease can infect not only though the natural resource curse, but strangely, also through other resources which are necessary for our country’s economic solvency.
No matter how perplexing, foreign exchange inflows through remittances, investments, loans and foreign aid can also lead to Dutch disease that may crowd out exports and manufacturing. The channel through which this disease spreads is always through the appreciating impact it has on the domestic currency.
Dollar inflows, irrespective of their source, all result in appreciating the rupee and cheapening the dollar, making manufactured exports uncompetitive and increasing reliance on imports.
This natural resource curse negatively affects manufacturing in the export non-oil sectors of all oil-exporting countries. It is well established that non-oil sectors in oil-exporting countries get squeezed with regard to either their GDP or to the oil sector.
Economists have seen a negative association between the exports of natural resources to GDP ratio and economic growth. This is not to say that oil wealth necessarily leads to poor economic development, but it works as a double-edged sword with benefits as well as costs.
Over the years, many oil-exporting countries, like Saudi Arabia, the UAE and Qatar, have succeeded in avoiding the pitfalls associated with oil wealth. But many African countries with abundant oil or other natural resources have yet to reverse the associated curse.
It would be unwise to call any natural resource a curse. It is so labelled because of bad economic policies and governance in the country. It is bad policies which act as a curse and constrain the realisation of benefits from resources. Our country is endowed with an ample population resource, which economist Julian Simon terms as the “ultimate resource”.
Due to poor policies, our labour is not fully employed, and from among both the employed and unemployed, some succeed in finding jobs overseas and send remittances home. These remittances reduce the current account deficit, thereby reducing the foreign exchange financing requirements.
It is bad policies which act as a curse and constrain the realisation of benefits from resources.
Yet, at the same time remittances make foreign exchange less scarce, thereby cheapening the value of the dollar and overvaluing the rupee (just think about the price of a dollar in a situation when we received no remittances.) The real exchange rate then acts as a confounding variable. It causes downward pressure on exports and manufacturing, making remittances appear like a curse.
This curse becomes visible in terms of a negative association between exports and remittances (both as ratios of GDP.) If we make a scatterplot of a time series of these two variables from FY1973 to FY2022, a downward sloping association between remittances and exports becomes visible.
Remittances, per se, do not cause exports to decline. It is the confounding variable — the exchange rate — which is the culprit. Sadly, this variable confounds our finance ministers also, who sometimes think the value of the dollar is around 165 or 200, when in reality, it is much higher. It also confounds the market which is blind for a while to the source of dollar inflows.
Foreign exchange coming in as an asset (from export or remittances) has the same appreciating impact as it would coming from a liability (loan or investment).
The market is not blind to this in the long run, but the economic damage usually occurs in repeated short-run sequences. What adds to the confounding nature of these adverse impacts is that when the market tries to impose an expensive dollar (depreciated rupee), finance ministers call this speculation and the central bank starts the witch-hunting of bankers and foreign exchange dealers! Shouldn’t these institutions be rewarded for at least doing something useful to lessen our Dutch disease?
How much appreciating pressure has been exerted by remittances and other inflows, together with home-grown bad exchange rate policies? When we analyse the monthly real effective exchange rate (REER) index (from July 2001) released by the State Bank and review the 12-month July over July per cent changes, the obsession of our finance ministers with overvaluation is easily spotted.
Although you really do not need to analyse this time series to establish the obsession, which is amply communicated through strange assertions about the exchange rate, it is important to statistically examine it.
Yearly changes in REER from FY02 to FY22 exhibit continuous bouts of real appreciations (conscious, but mistaken policy-driven) during FY04 to FY06 (three years), FY09 to FY12 (four years), FY14 to FY17 (four years), and FY20 to FY21 (two years). Each appreciation spell was followed by the depletion of foreign exchange reserves and balance-of-payments crisis, forcing the rupee to depreciate.
Most of these depreciations were not policy-driven, in contrast to appreciations. Herein lies the real problem. If our authorities take timely action (in normal times) to keep the rupee at a depreciated level, not only will imports be contained and exports gradually rise, but the rupee will not depreciate to the extent it does during a crisis.
Leaving the exchange rate to be truly determined by the market will mostly produce a depreciated rupee. However, the authorities chose to sell dollars in the market to produce spells of real appreciation described earlier by trying to control the rate.
While it is difficult to disentangle the strength of Dutch disease-induced appreciations from the folly of policy-driven appreciations, it is important to counter the disease as well as the folly by policy depreciations. The cure for both is the same and simple. It is not a strong rupee which makes the country stronger. An undervalued rupee consistently over several years will gradually make our economy stronger, which can then make the home currency stronger.
The writer is a former deputy governor of the State Bank of Pakistan.
Published in Dawn, December 2nd, 2022