The exchange rate debate is brewing up in print media, amongst seasoned economists and past policymakers. Some call for devaluation of currency, while others say it is imperative to correct the currency for sustainable external accounts.
Why is the debate heating up? The simple reason is that the current account is slipping which questions the sustainability of exchange rate. The need is to understand why and when the external account sustainability is challenged. And once that is established, the policy response is formed and implemented.
Last week, former State Bank Governor, Dr Ishrat Hussian wrote on article for Business Recorder followed by a counter article by former Finance Secretary, Dr Waqar Masood in the same paper the very next day.
Hussain argued that current account deficit is not the only factor as the deficit was 4 percent in FY06 as well; but BoP was in surplus because of higher FDI and borrowing from capital market and multilaterals. Now, these inflows are far and few to narrate BoP deficit in FY17. One may wonder why the FDI is low today - one reason could be bitter experiences of then investors as currency depreciation after 2008 eluded dollar based returns for telcos and other investors.
Anyhow, Ishrat further added that exporters do not get much advantage from currency depreciation. He talked about ‘Bandwagon expectations’ i.e. in days of depreciation exporters may withhold their proceeds in anticipation of further depreciation, while importers would rush to import more to get price advantage in near future. And he argued that buyers of exporters would negotiate on prices to have the major benefit of depreciation.
In the end, he emphasized on sound fiscal and monetary policies to not let the need for exchange rate depreciation arise. He is spot on; but if wishes were horses, men would ride.
The whole argument of exchange rate depreciation arose because of absence of structural reforms and poor policies.
His point is that exchange rate depreciation would stifle growth, promote unemployment and discourage foreign investment. Masood, on the other hand questioned the sustainability of the balance of payment - as long as reserves are high, current account deficit is tolerable. But the problem is that period of high reserves amid high current account deficit is simply not sustainable, unless, the debt keep on coming in at concessionary rates and FDI keeps on pouring in.
Sooner or later, reserves start falling and going back to IMF becomes unavoidable. And the fund asks for currency adjustment - that happened in 2008 and it may happen again in a year or two.
Another expert wrote against the devaluation mantra in print media earlier this week. Dr Manzoor Ahmed argued that devaluation would not impact imports since its demand is inelastic., rather it would increase the external debt servicing burden and would increase inflation. In his opinion, devaluation would hamper the foreign investors’ confidence.
The arguments of Ishrat and Manzoor are not for abrupt depreciation and even Waqar did not call for abrupt depreciation. BR Research opines that any abrupt depreciation is not good for economy; and but having an ostrich approach on external imbalances is in fact leading to a situation of sudden depreciation.
Imported demand in not inelastic for essentials; it is rather erratic for non essentials. For example, petroleum consumption has jumped in the past two years owing to low prices; staged manner increase in prices can reduce demand. But in case of imported items like cosmetics and others, price increase would not change consumer demand.
And in case of exports, all the rupee denominated products have become uncompetitive because of currency overvaluation. Meat export is on decline, and the country is sitting on 9 million tons of wheat stockpile simply because of unfavourable prices. And the list goes on.
Yes, there are demerits of currency depreciation. And delaying the inevitable would lead to a situation where an abrupt depreciation would become the only option.
A combination of increase in essential import prices and cash handouts to exporters should all be deployed along with curbing demand through monetary tightening. All these steps are imperative to not let the abrupt depreciation of currency which could kill the economic momentum.
We need to let the rupee slide to a point where it is able to move both ways that will keep the speculator on his toes. Until then, let everyone except governor SBP keep his mouth shut.
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