Raise productivity or else!

The value of the local currency has been unusually stable against US Dollar for the past fifteen months. The prevalent currency parity was initially targeted by Finance Minister Ishaq Dar, despite the broader markets views.
In those early days, most people expected the local currency to weaken and were busy converting savings to foreign currency, thus pressurizing the local currency further. Similarly, exporters were holding back their proceeds while importers were excessively chasing forward contracts.
There was no respite for the Pakistani Rupee. But thanks to the intervention of Darnomics, PKR has held steady in the range of Rs99-102 per USD. Lady luck is with Dar too as the euphoria started with Saudi gift of $1.5 billion in March 2014 was bolstered by depressed commodity prices and other flows from privatization proceeds and external loans.
The policy of sticky exchange rate has been heavily criticized by independent economists and researchers. Exporters have been adversely affected in days of enhanced competition and shrinking global trade. But Dar stuck to the task and didn't let the currency sway from his desired levels.
In the process, the real effective exchange rate (REER) moved from Rs101.7 per USD in February 2014, to Rs118.7 per USD in May 2015 - down by 17 percent. During this period, the nominal currency rate against USD remained almost unchanged and in case of many other currencies (such as Euro) PKR has appreciated.
Some say that a bubble is forming and sooner or later, it will burst. By delaying the inevitable the adversity of the impact is being increased. Some are wondering that why the REER is appreciating despite the fact that inflation at multiyear lows. The fall in inflation is primarily due to cost push factors and low commodity prices are keeping prices low everywhere, including Pakistan.
But to Dar's credit, he has slowly but surely been convincing stakeholders that his policy of sticky exchange rates is not all bad. In the latest budget, the Finance Minister has provided targeted relief to the sectors which were adversely affected by overvalued currency - better financing rates for textile exporters, higher duties on imports and a few other measures.
There is always an economic tradeoff between keeping currency artificially stable and bringing it to real value. The dividends that can be reaped from stable currency include bringing down inflation and lowering inflationary expectations. This helps in bringing interest rates down which has happened as the stable currency has lowered rational inflation expectations. Coupled with depressed commodity prices, this has brought inflation to the lowest level in 11 years.
Policy makers took advantage of the situation and bought discount rate down to the level in 44 years. Theoretically, this is beneficial for all industries including those badly impacted by not letting exchange rate find its real value. But will private credit pick up after the fall in interest rates? Not yet.
One may argue that power shortages and poor security situation have made investors averse from increasing stakes in the country. The situation has improved but it takes time to internalize the new reality - the businessmen are still in hangover of bad times and their confidence may improve in a few months time given that macroeconomics indictors remains positive.
The investment coming from China and other foreign inflows will help in boosting the real economy as once the wheels start churning, everyone will join the party. And if we take the economic growth to seven percent, the fear of crisis triggered by overvalued currency may subside.
The argument is simple: if we increase the supply of goods and services while not proportionately increasing the supply of money, inflation will come down. Resultantly, exports will pick up and imports growth will be muted.
But this is easier said than done. The need is to enhance the productivity of domestic industries.
The China package will really work if technology is infused to the domestic industry and labour force. Othwerwise the economic growth will not really pick up and the cost of keeping currency artificially high will overshadow the benefits of subdued inflation and low interest rates.
Dar cannot perpetually keep currency artificially high. It will correct once an exogenous shock hits the economy and that would be a painful process. It happened in 1998 and 2008. To ensure that this does not happen again in 2018, Dar and his team better work on enhancing productivity and increasing real economic growth.