Pakistan depreciated its currency against the USD by 5 percent in December. With a weakening dollar, the adjustment against few other trading partners is even higher. The currency adjustment amid fresh monetary tightening is meant to stabilize growing external imbalances; but the challenge is to keep a delicate balance by not letting mix of high growth and low inflationary era to compromise.
The growth story was hampered in 2008 due to steep depreciation, whilst trade balance was not improved much to the liking of depreciation prescribers. Enough has been said on what happened in the aftermath of 2008 depreciation - growth was reduced as inflation skyrocketed.
Today’s column attempts to draw lessons from the recent bitter experience of Egypt. Egypt devalued its currency by 50 percent i.e. doubled EGP/USD in Nov-16. The Egyptian Pound moved from 8.9 against USD to 17.4 within no time and it remained in the band of 15-19 since then. Currently it is trading around 17.6.
The external imbalances and the pressure of IMF made the country take such a drastic step. This sounds similar to what happened in Pakistan in 2008 and what a few circles are advocating even today.
The only exception is that the magnitude of depreciation in Egypt was way higher than what can be comprehended in Pakistan. And the impact of such depreciation in Egypt should supposedly be to boost exports and reduce imports.
After a full year of slashing the currency value by half, there is only modest reduction in trade deficit - it moved from $9.4 billion in Jul-Sep 16 to $8.9 billion in Jul-Sep 17. The exports marginally increased from $5.3 billion to $5.8 billion while there is virtually no reduction in imports. This simply tells, ceteris paribus, there is virtually no benefit of currency depreciation on trade balance.
The current account deficit, however, slashed by two third from $4.8 billion (Jul-Sep16) to $1.6 billion (Jul-Sep17). This reduction is essentially driven by higher services surplus on the back of travel/tourism receipts and surge in workers’ remittances.
The receipts on travel increased from $758 million to $2.7 billion in the period. This exceptional growth is owed to currency depreciation, as the tourism has become cheaper in dollar terms, and improved security situation in the country. Since international tourism is close to nothing in Pakistan, the currency depreciation may not have any impact on it.
In case of remittances, Pakistan can reap some benefit; but we have already extracted the low hanging fruits in the past decade. Hence, it is not at all recommended to devalue the currency for growth in remittances, as there are other means to attract money back.
What Egypt really gained in terms of external inflows is by attracting $18 billion in foreign portfolio money into local debt instruments (T-Bills). That is hot money that came in for higher returns from high interest rates and may vanish as fast as it came.
And in case of Pakistan, that benefit might not be there as international investors are not too keen to invest in Pakistan. A successful amnesty scheme (as done by Indonesia) could be a much better way to entice one time flows by native people money invested (parked) abroad. Due to the hot money and the IMF loan, net international reserves increased from $17.6 billion in Jun-16 to $36.7 billion in Oct-17. Barring portfolio investment of $18 billion, reserves’ increase is mere $1.1 billion or 6 percent.
And what cost did the Egyptian economy pay in the process? Inflation jumped from 13.6 percent in Oct-16 to a peak of 32.9 percent (Jul-17) before easing to 21.9 percent in Dec-17. The central bank increased benchmark rates from 11.75 percent (oct-16) to 18.75 percent in Jun-17.
All that yielded in attracting hot money which would evaporate as the dust settles. What the Egyptians would do once the inflation seeps into tourism to undo the gain. All of it to fetch $12 billion from the IMF? Is it worth the cost?
The simple answer is no. And it should be a lesson for other countries like Pakistan to refrain from such steps. Moderate depreciation has its advantages and Pakistan has already done that to preempt a crisis. The point is to not overkill any policy measure. The REER in Pakistan has moved down from 124 in Nov17 to 119 in Dec17 and it may come down to 115-117 in Jan18 as depreciation against Euro, British Pound and Japanese Yen is around 10 percent each since November.
The prescription for Pakistan is to sit tight and see the impact of recent moderate round of depreciation before getting too excited.
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