The flight of the rupee

From a purely demand-supply lens, it is clear that the demand for the USD far exceeds the supply that is available.
Published October 7, 2023

The Pakistani rupee has been the best performing currency over the last few weeks. The last time it became the best performing currency in Sept 2022, it lost 22 per cent of its value within four months of its best performance. A similar outcome is entirely possible this time around as well.

The incessant obsession with managing the value of the rupee against the US dollar has caused the government policy apparatus to exclusively focus on one metric — the PKR-USD parity — as a determinant of economic and social health, ignoring everything else in the process. The fallacy has been repeated so many times that the action and reaction of any administrative measures to bring the parity within a desired range works like clockwork.

Determining values

The value of a currency against any other currency is fundamentally a function of demand and supply. As demand for a currency increases, or as its supply decreases, its value also increases. Thousands of years of economic history testify to how the price of any good or commodity can never be fixed for long, and eventually the demand-supply dynamics prevail.

Over the years, Pakistan has become a consumption-oriented economy, heavily dependent on imports. For the last decade or so, consumption has made up more than 90 per cent of total national output. As consumption continues to increase in excess of available local supply, it starts depending on imports to satiate the demands of one of the fastest growing populations in the world.

A country can only import from a trading partner if it has some currency to offer that the trading partner deems valuable. Global trade is largely denominated in US dollars, Euros, Swiss Francs, Japanese Yen and the British Pound — currencies that trade partners deem valuable, and stable enough to accept. So for any imports to happen, a country needs access to these currencies.

As the quantum of imports increases, so does the demand for a particular currency. In the case of Pakistan, it’s mostly the US dollar, since our trade is predominantly denominated in USD.

 The PKR value against the US dollar over the last five years. — Screen grab via Google Finance
The PKR value against the US dollar over the last five years. — Screen grab via Google Finance

If there is demand, there needs to be supply as well. A country can build up supply of USD or reserves through a mix of export of goods and services, attracting remittances, attracting foreign direct investments, and through raising USD denominated debt.

Why Pakistan can’t get its dollar fix

In the case of Pakistan, as we became a consumption-oriented economy, we stopped investing in developing agricultural or industrial capacity that could generate export earnings and increase the supply of dollars.

The national hobby, over the last few years, became heavily tilted towards allocating capital to real estate and other non-productive areas, which could never generate any export activity. At a policy level, we discouraged investments in productive or industrial enterprises, as a result of which, any inflow of US dollars as foreign direct investments also dried up or dwindled. Our remittances continued to grow, but that actually fuelled more consumption in the economy, making things worse.

To support the increase in import-driven insatiable consumption, Pakistan started relying heavily on foreign currency denominated debts to fund its growth. But all good things come to an end, especially good things funded by lots of debt.

We have reached a point where the cost of foreign currency denominated debt has substantially increased, and Pakistan, given its inclination to always living on the edge, cannot borrow any more, save from a few friendly countries. Many of these friendly countries have also started cutting off the supply to unconditional capital.

In such a scenario, Pakistan continues to ration available foreign currency, prioritising repayment of debt first, followed by essential imports, and others. To grow even at a meagre 3pc per annum, Pakistan needs access to an additional $7 billion on an annual basis, just to fund its growth without changing the structure of the economy.

Such supply is not really available under the current circumstances.

From a purely demand-supply lens, it is clear that the demand for the USD far exceeds the supply that is available. In the short term, any supply of USD will only be made available through short-term facilities made available by friendly countries, and even those promises aren’t being kept at this point.

Till the time Pakistan can’t improve its ability to generate USD through productive enterprises, whether through export of goods and services, or through foreign direct investment in export-oriented industries, any flight of the rupee can only be short-lived, followed by a crash.

There exists a dire need to restructure the economy towards investment-led growth, wherein the investment is allocated towards export generating enterprises. In the absence of such a retooling of the economy, the rupee may not be able to stabilise, and may continue to be dependent on geopolitical rents, rather than sound productive enterprises.