The sharp currency appreciation in March 2014 has dampened the sentiments of manufacturing concerns. Exporters are losing competitiveness while others are threatened by import substitution as imported finished goods are getting marginally cheaper to domestically produced ones.
Lets delve upon a few indicators to gauge the impact of unwarranted currency movement on competitiveness of domestic industries.
Firstly, the focus should be on real effective exchange rate (REER) that captures the rate of inflation differential with trading partners. According to the SBP, REER was appreciating till December which means the currency was depreciating and industry was gaining competitive edge. Ever since then, the curves topple over - REER has appreciated by 8 percent in the third quarter to reach at 109.67. In order to have the same REER as of December 2013, nominal exchange rate had to be at Rs105.8 per USD today.
Then according to the IMFs projections, Pakistan's REER had to depreciate by 7.7 percent in FY14 but it has actually appreciated by 2.8 percent, so nominal currency has to devalue by 10.5 percent from today to June end to meet the funds expectations. This gives a good handle to see where the currency needs to be to counter the inflation difference with trading partners.
One may argue that the SBPs reserves have more than doubled since December to cover two months of imports and that explains the upward movement in currency. The other way to look is to see the relationship between the building of reserves and currency movement. Since March 2013 when reserves were similar to todays levels, REER has moved up by 4.7 percent (REER March 13: 104.7) and to be at equilibrium, the rupee should have been at 104.7 against the greenback. But it continues to hover around the promised number of 98.
Another gauge to measure competitiveness is to see what has happened to currencies of Pakistan's trading competitors. The textile exporters are fighting for same trough with Turkey and Bangladesh in the EU. Then India and Thailand, particularly, is giving Pakistan a real tough time in garments.
The table illustrates the relationship of reserves to the currency movement in five competitive countries. Interestingly, Indonesia, Turkey and Thailand, where reserves are manifolds compared to Pakistan's, have allowed their currencies to depreciate by a significant margin in the last year or so while the rupee today is hovering around where it was at the start of year.
While in India and Bangladesh, nominal currencies have appreciated or remained unchanged (similar to us), they are running huge export incentive regimes. This is to deal with monetizing the value of incentive to see the impact on actual exchange rate.
These incentives can be in the form of tax holidays, interest rates subsidies and so on. For instance, India has given tax breaks to its textile exporters upon Pakistan attaining the GSP+ status and that has diluted Pakistan's edge. There is a striking finding from a study conducted by eminent economist Dr Hafiz Pasha that due to incentives, exporters in Bangladesh are getting effective exchange rate at Takka 112 per USD - 40 percent more than its nominal exchange rate.
Then we need to look at competitive disadvantages to Pakistan and compute how much we need to compensate through exchange rate and other fiscal incentives. For example, effective cost of electricity (including load shedding factor) is much higher in Pakistan. And to add to the ado, currency appreciation is causing import substitution too.
Sources reveal that nearly 25 percent of Pakistan's yarn industry is recently (perhaps temporarily) replaced by cheaper product from India. Similarly ceramic players are finding it hard to keep prices at the levels or below the imported stuff from China of same quality.
The Ministry of Finance and the SBP need to conduct at least some back-of-the-envelope calculations and come up with some incentives through exchange rate depreciation, interest rate subsidy and import duties in the upcoming budget and monetary policy to counter the impact of adversaries, the industries are facing.
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REGIONAL RESERVES & CURRENCY MOVEMENTS
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Period Reserves Chg Currency chg
($ bn) reserves w.r.t USD
(%) (%)
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India Jun 2013-May 2014 284.6 311.8 10% -0.3%
Indonesia Mar 2013-Apr 2014 99.4 102.59 3% -16.6%
Thailand Jun 2013-Mar 2014 170.84 168.8 -1% -4.4%
Turkey Jun 2013-Mar 2014 119 126 6% -12.0%
Bangladesh Jun 2013-Mar 2014 15.3 19.2 25% 0.9%
Pakistan Jul 2013-May 2014 10.2 12.04 18% 0.3%
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Source: IMF, World Bank, SBP
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