PAK RUPEE depreciation

The upsides and downsides of devaluation of PKR

The country these days is in grip of serious uncertainty in regard to the fate of the Pakistani currency. Genuine businessmen are in a “wait and see” mode, the social media is full of arguments for and against devaluation while the speculators are busy spreading self-serving rumours. Pakistan rupee has devalued by 2100 percent over the last 70 years but the debate on the effects of devaluation remains unsettled and fiercely contentious.

PAK RUPEE depreciation – USD Rising

USD Rising after PKR depreciation – The upsides and downsides

of devaluation of PAK RUPEE

The purpose of this article is to provide a dispassionate analysis of the issue. Instead of taking a firm or doctrinaire position, we raise several questions and argue that the answers to these questions should guide the policymakers in arriving at a decision.

Economic theory tells us that the efficacy of devaluation depends on the competing effects of demand and supply side impact of the exchange rate. On the demand side, exchange rate has favourable effect as depreciation increases competitiveness and helps increase net exports. On the other hand, it may cause an increase in real interest rate and have a negative impact on investment and growth. On the supply side, depreciation has negative effects as domestic firms adjust prices in the event of both the changes in the exchange rate and prices of foreign goods. Most studies arrive at ambiguous results as the net effect depends upon these competing effects along with the form of exchange rate expectations. In some cases, devaluation has positive effect in the short run while in others it is not fruitful. However, in the long run, the effect of devaluation is neutral.

Empirical evidence suggests that there is no unique or correct way to measure equilibrium exchange rate. Trading partners ‘weighted exchange rate’ is different from competing countries ‘weighted exchange rate’. Most of the discussion of rupee overvaluation is based on Real Effective Exchange Rate (REER) published by the IMF. It is pertinent to mention here that in its November 2006 Article IV consultation Report, the IMF had estimated that the rupee was overvalued by 10 percent according to the equilibrium real exchange rate and external sustainability methods. But their estimates based on macroeconomic balance approach did not point to any overvaluation.

The next question is whether you use current account deficit only or look at the combined current account and capital and financial accounts together. The outcome may turn out to be quite different in two cases. In 2005/06, the current account deficit was nearly 4 percent of GDP similar to the current situation. But it was covered by foreign investment, borrowing from international markets and from multilateral institutions and the overall balance of payment ended up with a surplus of $ 1 billion that was added to the foreign exchange reserves.

Let us suppose that the Central Bank depreciates the currency by 10 percent. What would be the consequences? Some products that are unable to compete in the international markets at the current exchange rate of Rs 106 would be able to benefit as each dollar would now yield Rs 117 and they can cover their costs and make profit. This would bring additional export revenues to the country. Some of the local industries would be able to profitably produce import substitutes as the prices of competing imported goods go up. Both of these responses would help in reduction of trade imbalance. Some of the workers’ remittances that are at present diverted to informal money changers may be channelled through the banks. Thus the current account deficit would be lowered compared to the present level. How long will this benign and positive impact last would depend upon the future expectations. In Pakistan, it has been observed that Exchange rate expectations are not formed rationally but follow the Bandwagon effect in the event of discrete devaluation expecting further depreciation in the future. In case the net effect of devaluation on the balance of payments is either neutral or negative or the reserves are not maintained at a reasonable level “Bandwagon expectations” kick in. Exporters withhold their supply of dollars in the interbank market hoping to get a better rate after 90 days-the maximum time allowed to surrender foreign exchange. Importers would rush in with their requirements for next few months to take advantage of the prevailing lower rate which they expect is likely to depreciate further. The market would thus be short of supply and high in demand for dollars and the rate has to move downwards to clear the market.. The expectations are fulfilled.

How are these “Bandwagon expectations” formed? As soon as the currency is depreciated, the foreign buyer will demand from the existing exporters at least 5 percent price discount out of their 10 percent incremental earnings as if these were windfall gains and not a correction to price distortion. Then 40 percent of our exports are using imported raw material directly or indirectly (fuel, LNG, etc). So the cost of this 40 percent inputs will go up and the net gain to exporters will be limited to 2-3 percent as a result of 10 percent currency devaluation. But at the same time, the prices of imported goods will rise resulting in higher inflation. Inflation will adversely hit the poorer segments of the population as they have no assets except their labour and in an informal economy with high underemployment, the wages do not necessarily rise at the same rate as do prices. The central bank will have to raise interest rates to curb inflationary expectations and this would push up the cost of domestic capital. Imported capital goods will now cost more and some of the investment may have to be curtailed, postponed or abandoned lowering the investment ratio and growth rate. Fiscal deficit will also widen as the debt servicing burden in rupees would rise by10 percent partially offset by the higher import duty collection. Government borrowing from banks to tide over high fiscal deficits would crowd out the credit to the private sector further impeding investment and growth. Foreign investors would see their profits in dollar terms decline, discouraging them to bring in new investment. Market players therefore conclude that after the initial gains, the exchange rate would once again come under pressure because of these second and third order effects of devaluation.

What does the recent historical record inform us? During 2002-07, the US dollar traded around 60 rupees and the exports doubled while in the next five years the rupee depreciated by 51 percent but there was no corresponding increase in the value of exports. In the earlier period, inflation relative to trading partners was quite low and fiscal deficit was under control. In the latter period, inflation reached its peak of 23 percent and fiscal deficit had widened to 8 percent of GDP.

The lesson to be drawn from this historical evidence is that sound fiscal and monetary policies are critical to macroeconomic stability. The need for exchange rate depreciation in that event does not arise. To rely solely upon a blunt instrument such as exchange rate while other policies are moving in the opposite direction would prove harmful to the economy.

Markets are based on sentiments and it is essential to maintain the confidence of market players by avoiding the circumstances that form the Bandwagon expectations leading to pressure on exchange rate and depletion of reserves.

To conclude, unlike politics, the art of economic management involves tough policy choices and trade-offs. Each policy creates a set of winners and losers. To decide whether we should opt for depreciation, policymakers have to address the following questions: Are we prepared to curtail current account deficit and external borrowing and live with higher price inflation and lower growth rate? Are we in a position to accept higher unemployment and underemployment as a result of lower growth rate that would follow escalation in the prices of imported capital goods and raw materials for industry? Are we willing to slow down the present momentum of foreign investment and loans by the Chinese companies that would help us in tiding over energy shortages?

Shouldn’t we consider alternate policy instruments that reduce the cost of production of our exporters making them competitive by giving them cash rebates expeditiously, resolve their liquidity problems by doing away with the present system of advance payments of taxes, duties and then granting refunds, minimize the interaction of exporters with many agencies of the Federal and provincial governments, give preference to them in allocation of gas, power, water, land etc? Can there be a more simple, transparent, electronically driven, unified method of assessing and collecting taxes, cesses, fees, and other government dues of the federal, provincial and local governments with least discretionary powers in the hands of tax collectors? Should additional incentives be given to the banks which are able to mobilize workers’ remittances beyond the threshold levels? Should import duties be raised on non-essential luxury imports while strengthening surveillance on customs officials?

The answers to the above questions after calculating the net benefits of each of these policy decisions should guide the central bank authorities in determining whether we should go ahead with discrete devaluation or not. However, maintaining an unrealistic exchange rate is not sustainable in the medium term. By depoliticizing the exchange rate policy and allowing the central bank to pursue its policy of managed float with a two-way movement of the exchange rate in the inter-bank market, adjustments can be made to minimize misalignments, maintain a realistic rate and thus defuse the stimulus for the formation of “Bandwagon expectations”. But it requires that no political statements about the level of exchange rate should be made and the Central Bank allowed to do the job without any outside interference. The Bank staff monitors continuously the inflows and outflows, examines the economic conditions in the trading partners, global commodity prices, policies of the competitors and many other variables and then make judgement call. Experts and outsiders even like former Governors do not have complete information and data. They should hesitate from making these calls as they can only speculate on the basis of their priors and thereby confuse the economic players. Other countries who have empowered their Central Banks have seen stability and calmness in the markets.

Impact of currency depreciation

The currency has finally started heading south. It depreciated by around 5 percent in the last few trading days. The noise is that the SBP would keep it around Rs110-112 per USD for the time being, and see the impact on macroeconomic variables, and decide accordingly. This seems to be the right approach, and BR Research has been reiterating the same.

The question is the plausible impact of depreciation on other economic variables and what parallels can be drawn from 2008. Intuitively, any fall in the rupee value would bring imported inflation home and in turn the domestic demand would be curtailed.

This implies that the economy could move from low inflation and high growth era to high inflation and low growth period. That is not desirable as this adversely impacts two fundamental objectives of economic management i.e. employment generation (worsens due to low growth) and affordability of goods and prices (falls due to high imported inflation, and high interest rates).

If that is the case, why urgency? The problem is rising balance of payment worries or growing current account deficit, which is taking reserves to uncomfortable levels. Thus, the currency adjustment is to readjust the trade deficit, primarily, and higher inflation is a side effect.

The need is to carefully evaluate the intended and unwanted outcomes of currency depreciation. Apart from inflation adversaries and its impact on growth through curtailed domestic demand, it could hamper fiscal balance by increase in debt servicing- both on foreign loans (direct impact) and on domestic debt by subsequent higher interest rates.

Let’s try to evaluate the impact of 5 percent recent currency depreciation on imports, exports and inflation based on past experiences. In case of inflation, in 2008 when the currency went through a sharp depreciation, inflation impact was a little too much. The question is would the prices respond in similar fashion this time around?

There is a fundamental difference in the prices of basic household goods today than what it was in 2008. At that time, a few key commodities were at steep discount to international prices while today some of them are trading at premium. For example, wheat in March 2008 was at 35 percent discount to international prices and today its 100 percent higher than international prices.

Similar is the case of milk spot prices, which were at 20 percent premium to world prices in 2008 while the premium is 110 percent today. Similar are the results for fertilizer and petroleum prices. There is commodity supply glut both at home and abroad; but the prices are here high due to support prices and its cascading affect, in case of food commodities. For fertilizer, doing away with subsidies and higher gas prices have resulted in higher prices at home. And in case of petroleum, there is room in taxes to nullify the impact of currency depreciation.

The impact of any depreciation this time around would not be too inflationary as domestic prices are already higher than global averages. The good news is that it won’t bring too much imported inflation and in turn its adverse impact on growth through demand adjustment would not be much.

The bad news is it would not curtail essentials’ imported demand unless petroleum prices are revised up. There will, however, be some price increase in automobiles, energy and few other sectors. And imports in these sectors might take a dip.

More important is to see the impact on exports. It is good for the exports as they would get theoretically 5 percent more cushion.

This is in addition to 4-7 percent cash rebate in textile package which should be utilized swiftly. However, there is intense competition to Pakistan exports. It’s a buyer market; and seller would have to share part of increased margins. And imported raw materials would also partially nullify the gains.
Apart from manufacturing exports, it’s time to get rid of wheat and sugar surpluses lying for years before they get rotten. The subsidy requirement would be reduced.

In nutshell, exports would benefit more. However, imports may not fall much. And inflation impact would be still in control. The currency should stick to new levels for a few months to see the actual impact.

Rupee devaluation in Pakistan? Currency drops most in 9 years

Pakistan’s rupee plunged the most in nine years, after the central bank was said to have devalued the currency as South Asia’s second largest economy showed signs of stress ahead of elections next year.

The rupee fell 3.1 per cent to 108.1 against the dollar at 2:29 p.m. local time on Wednesday, the lowest level since December 2013, according to data compiled by Bloomberg. The move was a “long overdue” devaluation, Karachi-based Topline Securities said in a research note. State Bank of Pakistan spokesman Abid Qamar declined to comment.

The International Monetary Fund last year pointed out that the currency, which operates under a managed float regime, was overvalued by as much as 20 per cent and was negatively impacting its exports. In an interview last month, Pakistan’s Commerce Minister Khurram Dastgir Khan said he was trying to persuade Finance Minister Ishaq Dar to adjust the rupee’s value after the devaluation of currencies by regional players including China, India, Turkey and Thailand gave them an edge over Pakistan.

The central bank “did the devaluation by allowing some import payments to be made through the interbank system,” Fawad Khan, research head at BMA Capital Management Ltd., said by phone.

Falling Exports
The move may help the nation curb a rising deficit and boost falling exports as Prime Minister Nawaz Sharif looks to contest national elections next year. The nation’s trade gap has increased about 60 per cent to $3.5 billion in May compared with same period last year.

The rupee’s strength “was leading to a wider current account deficit and depreciation pressure on the currency,” said Divya Devesh, a Singapore-based Asia foreign-exchange strategist at Standard Chartered Plc. “We were forecasting a move toward 108 in USD-PKR by end-year.”

The IMF last month said economic stability reached under a three-year $6.6 billion loan program that ended last year has begun to erode. Pakistan’s current account gap has more than doubled to $8.9 billion in 11 months ended May compared with $3.2 billion in the same period last year.

Depreciating the rupee

There has been an ongoing debate about whether the Pakistani rupee would remain stable against the US dollar. The World Bank and IMF have advised Pakistan to depreciate its currency to improve its balance of trade – but Pakistan’s financial managers have continued to reject the logic. Last Thursday, the Pakistani rupee began depreciating suddenly against the US dollar and ended at around four percent less on the same day. After reaching a high of just over Rs110 to a US dollar, it stabilised around Rs106.5 to a US dollar. The burning question was: is this a chance event or a policy decision? Given how much resistance the government had put up to the IMF and other international agencies, at the time it seemed unlikely to be a government decision. However, it has turned out that it was indeed a policy decision taken during a meeting between the IMF and the finance ministry. The government seems to have succumbed to IMF dictates once again rather than taking an independent decision. This is what perhaps explains why the UN Economic and Social Commission for Asia and the Pacific issued a warning to Pakistan last week that it would be difficult for the government to keep its exchange rate stable in the current environment. But it is still a strange decision – especially since it appears to have been deliberately timed to be taken after Pakistan’s decision to raise $2.5 billion through bonds.

The logic for issuing the bonds first and then devaluing the currency does not seem obvious, since the bond issue is in US dollars. However, the new bond issue could work to improve the government’s position to be able to stabilise the Pakistani currency at a point of its choosing. The decision to devalue the currency could have benefits but also has significant risks. Currency devaluation is a strategy designed to suit net exporters, not net importers. Pakistan is in the position of having its trade deficit spiral out of control. There is no logical reason why the decision to depreciate the currency would lead to an increase in exports. Instead, it could end up increasing the cost of production for some export-oriented industries through the indirect effect on wages, import costs and oil prices. All is not well with the Pakistani economy just yet. Both economic growth and inflation in Pakistan are set to rise, but the biggest issue remains the ballooning current account deficit. There are no easy solutions to arresting this decline. This is why it is even more difficult for the Pakistan government to predict where the currency might stabilise. And once you open the door to currency speculation, the ability to predict where it will land is much harder. It will be important to watch the changes in the value of the rupee closely this week.

A weak rupee is a result of macroeconomics, not conspiracies against the state

It’s a boon for some and a curse for others. The sudden devaluation of rupee has gone largely unnoticed in Pakistan. Yet the devaluation will impact most Pakistanis.

Those receiving remittances from abroad will see some extra cash in their pockets. At the same time, the price of imported goods (petrol, tea, cooking oil, etc.) will rise, tightening household budgets all around.

The 24/7 coverage of the political circus combined with a judicial inquiry has left little room in print and electronic media for matters that matter. An exception was Khurram Hussain’s exposé in the Dawn about the larger economic impact of currency devaluation.

Currency exchange rates are explained in most beginner texts in macroeconomics. Pakistan’s import bill will increase whereas exports will be cheaper and hence more competitive globally, leading to growth in the export sector.

The increase in the price of imported goods will support inflationary pressures. The resulting uncertainty could lead to lower domestic consumption that might not be offset by the growth in the export-oriented sectors.

If the rupee continues to slide, the government might have to revise interest rates upwards to arrest the flight of capital. The same instrument will be deployed to arrest higher than expected inflation.

Pakistani rupee, like all other currencies, has gained and lost value in the past. It will do so in the future as well.

What should be of interest to our readers is if the timing and determinants of the current devaluation are an outcome of larger macroeconomic conditions or if there are other dubious forces trying to manipulate the markets, as finance minister, Ishaq Dar, alleges.

Is Mr. Dar to be believed or the central bank? Is every development, or the lack of it, in Pakistan a conspiracy against the ruling class, or is there a greater economic system whose fundamentals impact Pakistan as much as they impact other nations?

Currency manipulation, or at least the accusations about it, is not uncommon. Export-oriented economies are often accused by others of manipulating their currency to lower the price of their exports.

For instance, the US President, Donald Trump, in the past called the Chinese “grand champions of currency manipulation.” During the presidential campaign, Mr. Trump often accused the Chinese of lowering their currency to maintain the competitiveness of Chinese exports.

Mr. Trump did have a change of heart in April this year when he declared that China was “not a currency manipulator.” He found another reason for the strong US dollar. “I think our dollar is getting too strong, and partially that’s my fault because people have confidence in me,” declared the American president.

Mr. Dar, it appears, takes inspiration from Mr. Trump and takes credit where it’s due and also where it’s not. In a statement after rupee devaluation, Mr. Dar declared that “[d]espite the eight to nine-billion-dollar current account deficit, if the reserves are still, by the grace of God, sitting at $21bn, it is because our team has performed that they are there.”

The operative comment in Mr. Dar’s statement is about the eight to nine-billion-dollar current account deficit, which exposes the sustained decline in Pakistani exports that now lag imports by billions of dollars, an untenable financial scenario.

For years, the Pakistani government has deliberately propped up the currency. Bloomberg reported recently that commercial banks were told not to trade rupee at levels unacceptable to the State Bank. In fact, Pakistan’s rupee remained the only currency to hold its ground against the US Dollar when almost all other regional currencies slid.

There is, however, an obvious downside to artificially propping up the currency. While it may provide justification for some false sense of pride or financial stability for the naive, it erodes export competitiveness.

Pakistan’s $9 billion current account deficit (a measure of weak exports against imports) will continue to widen if rupee were not devalued.

The concerns about an overvalued exchange rate are by no means new revelations. The IMF had warned government last year that the rupee was overvalued by as much as 20%.

In a July 2016 report, Bloomberg reported IMF’s concerns about the overvalued exchange rate and its impact on the weakening of Pakistani exports especially when other regional economies had adjusted their currencies to compete in the international market place facing a slowdown in consumption.

Currencies rise, and they fall. That’s not a concern.

What matters is when political brinkmanship takes precedence over national interest. When those elected to mind the nation’s finances view everything from a bipartisan political lens, problems arise.

When the rupee devalued last week, the finance minister, Ishaq Dar, accused “individuals, lenders, and entities” of “exploiting the current political situation.”

However, the State Bank of Pakistan saw the devaluation to be “broadly aligned with economic fundamentals” and that devaluation is likely to support growth in exports in addition to addressing the “emerging imbalance in the external account.”

It is an opportune time for the government to do the right thing. The recent appointment of Tariq Bajwa as the new governor of State Bank must be followed with a commitment to grant operational autonomy to the central bank so that it may conduct its affairs (including managing the exchange rate) independently and in the best interest of the nation.

Are you an economist and have a take on whether a weak rupee is in Pakistan’s national interest? Write to us

Market wakes up to sharp rise in US dollar rate

KARACHI: The market was caught off guard today after both the interbank and open market rates of the US dollar saw a substantial rise.

At the start of the day, the US dollar rate had increased by Rs4.5 in the interbank market and Rs1.5 in the open market.

However, the US dollar is trading at around Rs106.5 in the interbank market and between Rs107.8 and Rs108.8 in the open market.

A spokesperson for the State Bank of Pakistan (SBP) said that market forces set the rate of the dollar, after keeping in view the demand and supply.

He added that they are keeping an eye on the situation.

The spike in the dollar rate caught the market by surprise, especially since the SBP announced on Thursday that it had received $2.5 billion earned from the recent issuance of euro and sukuk bonds.

Last week, Pakistan raised $1 billion in a five-year Sukuk and $1.5 billion in ten-year Eurobond transactions.

State Bank receives $2.5 billion from issuance of euro and sukuk bonds

Normally when supply increases, like it did yesterday, the market stabilises as the balance of payments increases.

However, analysts said that the current account deficit and related factors were building pressure on the economy which resulted in today’s incident.

Economist Muzammil Aslam told Geo News the dollar rate increase leads to a rise in prices of food items, petrol and services.

He said that a positive aspect of the increase in the dollar rate is that the country’s exports, which have dipped in the past several years, can increase along with the country’s industrial output.

Aslam also said that today’s move could also be a result of the delayed devaluation of the Pakistani Rupee, which has been delayed for over a year.

Moreover, on Thursday, the ongoing political uncertainty in the country took its toll on the Pakistan Stock Exchange, with the KSE-100 index falling more than 1,100 points.

Around 3pm on Thursday, the benchmark index was less than 38,770 points after a fall of more than 1,100 points.

Pakistan Press Club