Is our rupee overvalued?

Economists and independent think tanks maintain that the rupee is overvalued by around 15 percent, while the sixth review report of the International Monetary Fund (IMF) notes that the rupee is over valued to the tune of 10.6 percent since the programme began in September 2013. The Dar-led Finance Ministry refuses to accept that the rupee is over valued. What is the actual position?
The third time Prime Minister Nawaz Sharif has, during his previous two stints in power as well as in the present, unambiguously supported a strong rupee vis-a-vis other currencies. This preference is based on his misperception that a strong rupee implies a strong economy. A relevant example for the prime Minister to take note of is the decision by Danish monetary authorities to lower interest rates into negative territory to reduce upward pressure on their currency days before they expected the European Central Bank to announce large-scale bond buying that was expected to push the value of the euro further down. The Danish example indicates that a negative rate of interest to keep the currency value low is a policy decision supported by economists to ensure export competitiveness and may go some way in explaining why our exports continue to decline irrespective of the grant of GSP plus status by the European Union.
An economist would conclude that a strong rupee is a symptom of a strong economy and not its cause. Federal Finance Minister Ishaq Dar unfortunately appears to agree with the Prime Minister and has followed the instructions of his party leader and, since the free fall of the rupee while the two men were in Washington DC in the last quarter of 2013, has ensured that the rupee-dollar parity remains stable at around 100.
The question is why did the rupee go into a free fall in 2013? From September 2013 to January 2014 the rupee declined to as low as 112 to the dollar and three major factors accounted for this erosion. First foreign exchange reserves plummeted and it was only after Saudi Arabia gifted the 1.5 billion dollars that the depreciation was arrested and reversed. Second, borrowing increased significantly - domestic, which crowded out private sector borrowing, as well as external - accounting for an ever-rising budgetary allocation on interest payments (33 percent of the entire 2014-15 budget has been earmarked for interest payments) thereby shrinking the pie for development. And finally, productivity continues to remain hostage to flawed policies including failure to improve the taxation structure (which to this day continues to rely on raising taxes on existing taxpayers rather than on broadening the tax base for higher revenue generation), delays in refunds to exporters, appallingly poor performance of the energy sector as well as in other key sectors of the economy and insistence on an ambitious target for reduction in the budget deficit which is compromising the economy's growth rate.
To ensure that the rupee remains propped up the Federal Finance Minister ensures that foreign reserves remain high - a feat that is not attributable to higher exports or productivity or reforming the tax structure but on borrowing, directly from multilaterals and bilaterals and indirectly through issuance of Eurobonds and Sukuks at well above the market rates prevalent in the global market. Foreign Direct Investment continues to decline and it is only a rise in remittance income that is contributing positively to the rupee strength. However its impact is insufficient to prop up the rupee at around 100 rupees to the dollar and the Finance Minister has had to rely on a compliant State Bank Governor to intervene in the market as and when directed.
The Pakistani rupee is linked to a basket of currencies and data released by the State Bank of Pakistan (SBP) indicates that it has intervened in the market to prop up its value over the past almost two years of the PML-N government. The intervention has been through (i) open market operations namely sale/purchase of bonds securities, (ii) sale/purchase of dollars and/or (iii) adjusting the interest rate that has implications on the value of the currency by reducing its demand.
Be that as it may, the PML-N leadership has time and again argued that lowering interest rates would encourage private sector borrowing with the capacity to fuel growth; but unfortunately what the current batch of economic managers has done is enhance its own borrowing and crowd out private sector borrowing. And to make matters worse it procures loans to fund its current as opposed to development expenditure which implies that the growth component of borrowing is minimal. Institute for Policy Reforms, an independent think tank led by Dr Hafiz Pasha, noted a 9 percent cut in federal PSDP and a combined provincial cut by 32 percent of provincial PSDP in the current fiscal year.
Higher growth implies higher employment opportunities which fuel private consumption. In this context it is relevant to note that the Musharraf era was marked with foreign inflows in the aftermath of 9/11 which translated into more than doubling of consumption - from 3.6 trillion rupees in 2002-03 to 7.9 trillion rupees in 2007-08 for private consumption while government's current (as opposed to development) consumption rose from 428.7 billion rupees to 1.2 trillion rupees in the two years (or tripling). In the first year of PPP-led coalition government (2008-09) private consumption was 10.45 trillion rupees which rose to 18.56 trillion rupees while in 2012-13 Economic Survey the Dar led economic team did not provide government current expenditure but government final consumption expenditure making any comparison difficult; and claimed that from 2.465 trillion rupees government final consumption in 2012-13 rose to 3.047 trillion rupees in 2013-14. But the dramatic rise in consumption during the past one year and three quarters is mainly for current expenditure that does not reflect any increase in productivity.
To conclude, there is a consensus amongst economists that a lower value of a currency fuels exports while a higher value would make exports uncompetitive with repercussions on exports, corporate profitability as well as employment levels. In addition, given our porous borders smuggling of foreign items into Pakistan increases as our rupee value strengthens and our large illegal economy would simply grow to favour neighbouring countries. It is disheartening that the Finance Minister engaged in heavy borrowing from abroad is holding the rupee hostage to reducing the interest payment component of the budget while ignoring its implications on the rest of the economy.