It is interesting to note how history repeats itself in case of PKR/USD exchange rate dynamics in Pakistan. Politicians, economists and finance ministers in few countries, including Pakistan and Turkey, still believe that by using the tool of ‘talk down’ they can reduce volatility and/or bring the exchange rate to a desired level.
After the official euphoria on reaching the IMF (International Monetary Fund) deal and Saudi petrodollars landing in our begging bowl any day, tapered off and failed to bring down the PKR/USD to 167-170 in matter of hours/days, the able Advisor on Finance and Revenue pulled out another tool of ‘talk down’ to bring down the PKR/USD rate.
This is not a new tool and has been used previously by finance ministers in Pakistan with little success. Unfortunately, living under the shadow of ‘Washington Consensus” it is very difficult as the following travel in time tunnel reveals.
At operational and theoretical levels, it also raises the following set of questions: Does ‘talk down’ facilitate in bringing the exchange rate to a desired level and with how much lag? Is it a forerunner for administrative and policy actions to actively influence the market sentiments? Has the effect of ‘talk down’ on managing exchange rate volatility been isolated empirically from the other fundamental macro/micro indicators? In the end, is it a political gimmick or does it really influence and for how long a day, a week or a month the market sentiments/speculation for a given episode of volatility? Should Ministry of Finance even ‘talk’ about the exchange rate movements when it is in the domain of SBP (State Bank of Pakistan)?
Soon after the PML-N took power in May, 2013, the government warned in December 2013, that “those banking on dollars should ‘cash them in’ with the exchange rate expected to drop soon”, according to a leading English-language newspaper. What a coincidence! The ‘talk down’ emerged as the monthly average PKR/USD exchange rate depreciated from 98 in June 2013 to 107.51 in November 2013. As per the article, it was reiterated that the government was making efforts to bring the exchange rate down to the 1998 levels (=PKR.46). Luckily, thanks to external factors, reaching a new agreement with the IMF, and/or selling USD in the market, the PKR/USD came down gradually from 106.94 in Dec’13 to 98.59 in May’14 before rising above PKR 98 in August’14. Bringing it down to PKR 46, however, remained a pipe-dream. With a simultaneous play of the above-mentioned factors, bringing it down in a matter of 4 months was solely due to ‘talk down’ remains an empirical exercise. The PML-N government managed to keep the exchange rate fixed around 100-105 till 2017 at the cost of stagnant exports. Criticism of many gurus on quasi-free float of PKR linked to SBP autonomy is also based on failure of ‘talk down’ tool in managing stickiness of exchange rate.
Credit goes to the current advisor/finance minister in using the REER (although lagged by a month or two) as a yardstick to advertise PKR’s undervaluation and not making heroic statements like some of his predecessors to gain political mileage.
Exchange rate determination in developing countries with weak fiscal and BoP (balance of payment) sustainability is vulnerable to many shocks, namely economic, political and regional/global. Statistically speaking, its movement is reduced to a ‘random walk’ in the short to medium run.
One should also admit that the factors determining the current exchange rate dynamics are not exactly comparable and even more complex than prevailing in 2013. The use of ‘talk down’ tool for managing exchange rate movements may be more redundant now than in the last government for the following reasons: a) the knowledge (level) and determinants of REER including rational expectations of inflation rate differentials across the trading partners is now more widespread. Thus REER’s current index value of around 94 is not making any dent in the stickiness of the exchange rate; b) our foreign debt profile, including payment obligations in the short to medium terms, is now more vulnerable than it was in 2013. Thus good news on expected reserves and shift of more debt to future generations is not removing the stickiness in our exchange rate; c) strength of USD against other currencies via expected capital flows to US and uncertainty in giving a timetable by the Fed for tapering off policy rate cycle is further compounding the PKR/USD exchange rate conundrum; d)regionally, how the shortage of cash USD in Afghanistan will be dealt with by the multilaterals and the dynamics of common currency area by Pakistan also add another layer to stickiness in the PKR/USD movements; e) how much continued increased remittances flows as well as investment in start-ups put USD under the pillows of expats families and new start-ups (services sector), and how much is drained out due to inflation remains an empirical research question. If it is a net gain it adds to the USD retention capacity of households and firms, and may not be sensitive to ‘talk down’.
The retention power can be measured by a soft indicator of growth in FCA (Foreign Currency Account) since July’21 compared to earlier periods; and f) with textile exports driving the overall exports to double digits, partly due to various fiscal and monetary freebees, the exporters’ USD retention capacity is at all-time high and they may be waiting for the realization of rating companies forecast of PKR 180 by the end of 2021. Many may have substituted cash from sale of stocks or existing bank deposits to meet the increased input costs and take full advantage of time provision to delay the surrender of foreign exchange earnings via banks.
Combining the historical evidence with the above complex set of factors determining the stickiness of PKR/USD in moving quickly towards the range of PKR 167-170, the tool of ‘talk down’ may not serve its intended purpose in this quasi-casino economy where fast real profits (thanks to negative interest rates) can be made in real time by quickly shifting undeclared income and profits to many alternate wealth creating channels.
Copyright Business Recorder, 2021
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