Exports and currency devaluation: any link?

Any increase in exports is always a function of the elasticity of the inputs that make up the goods exported. These inputs are multifaceted, subject to factors including but not limited to technological advancement, research and development, education and skill level, economies of scale, law and order situation, political stability, and most importantly, competitive advantage in the production of goods. In a recent analysis published on Twitter, it was posited that a “favorable exchange rate” explains the increase in export quantity in recent years.

However, this analysis fails at many levels; firstly, as it is outdated, neglecting to account for the monumental export growth achieved in the past year alone, only considering values up until a certain date in 2020; and secondly, by making a false attribution between exports and exchange rate where no clear link is present.

Above all, considering a sole factor such as exchange rate results in a unidimensional and therefore fallacious analysis, contrary to which there is extensive literature revealing that the relationship between the indicators of exports and exchange rate is statistically insignificant.

Numerous studies cover the theoretical as well as empirical aspects in order to demonstrate the complex relationship that exists between currency level in a country and its trade, making it near to impossible to chalk out a clear causal effect.

In one study, Hooper and Kohlhagen (1978) established a trivial and negative association between exchange rate of a country and its trade. Furthermore, all inputs of Pakistan’s exporting sectors are dollar based, including but not limited to raw materials, energy, dyes & chemicals, machinery and spare parts etc, and it has been ensured that they are measured in dollars in order to reduce risks posed by currency volatility, thereby providing an unwavering and secure economic and investment climate.

Being a developing country with a high inflation rate, Pakistan implements full dollarization for its industrial imports. This itself refutes the concept of debilitating exchange rates affecting the trade of the country.

In FY21, Pakistan’s goods and services exports amounted to nearly $31 billion. This growth was shown to be aided mainly by three factors: lower interest rate, regionally competitive energy prices, and a lower cost of doing business. While there have been, to a certain degree, supportive policies for the export industry over the past 3 years, this support has given back to the economy manifold, due to the multiplier effect of export growth.

As an example, Bangladesh’s export-oriented industry benefits from unwavering government support, competitive energy and exemplary DLTL system which strengthens its exporting industry as the mainstay of the economy.

This is why the economy of Bangladesh is now ranked the fastest growing in the world, in stark contrast to Pakistan’s case where government support for industry is deemed to be a “subsidy.” To the contrary, a subsidy is defined as financial aid or support in order to bring costs below the market rate, while the exporting sector in Pakistan flounders to obtain the very basic market rate and nothing below that.

Competitive energy rates are not subsidies; they are the minimum requirement for the industry to remain at par with regional competitors. Supportive policies that included competitive energy enabled the industry to attract sufficient investment to begin expansion in capacity and technological upgradation.

However, recent policy instability threatens to reverse the industry’s progress. It is critical to prevent this from happening, by continuing the provision of energy at regionally competitive tariff rates, for the country’s long-term economic stability and GDP growth.

Even with these minimum requirements, Pakistan’s export based industry is far from achieving the necessary upgradation and innovation. Systemic inefficiencies, administrative delays, and ever increasing cost of doing business all have contributed to an unsustainable business environment, and each of these factors must be considered each time there is talk of export numbers.

Pakistan relies on very limited items for its exports, rendering its export base very narrow with a focus on low value-added products. These include products related to textiles, agriculture, pharma sector etc. These prominent categories of exports contribute to more than 70% of total exports with textile exports solely contributing more than 60%.

Pakistan has not increased its export base as it lags behind in terms of product diversification, with narrow market capture and a low-tech based production competing against constantly evolving global players. This signifies that a factor like exchange rate has no significant effect on a narrow base export economy like Pakistan, a point emphasized previously in a study by the National Tariff Commission of Pakistan titled “Impact of Exchange Rate on Pakistan’s Exports”.

It is important to note that prior to any assessment of the impact of exchange rate depreciation on exports, imports and employment, one must consider the overall state of the country’s economy and policies. The rupee plunged over 58 percent against dollar in 2021 as compared to 2015 on average (from Rs 103 to Rs 163).

Following this currency devaluation, the cost of doing business rose due to increasing prices of energy, raw materials and freight. This devaluation served as beneficial for one group in particular: domestic producers such as cotton farmers, who benefited from both the devaluation of currency and the rise in international prices of cotton. In the last season, cotton farmers were paid Rs 400 billion additional payments on account of higher international cotton prices.

The export sector experienced a period of stagnancy up until recently, as the costs of doing business far outweighed government support, leading to an unsustainable environment for export-led growth. The costs of doing business were racked up by persistent issues in pending refunds of exporters (some of which still remain pending), load shedding, high energy costs, high interest rates, all of which reversed any supposed positive impact of rupee devaluation.

Three primary factors influence the impact of depreciation on external trade and related sectors. Domestic pricing, inflation in other countries and macroeconomic conditions and policies during the devaluation phase. The first two components determine the real effective exchange rate and external competitiveness. The nature of exports and imports, as well as export capability, determines the benefits. The amount of depreciation that contributes to greater economic activity and hence increased export capacity is determined by macroeconomic conditions and policy. The profits from depreciation would be compromised if any of these aspects were lacking.

There was no rupee depreciation during the PML-N’s tenure when inflation was low. Even a small depreciation of rupee then could have effectively lowered the exchange rate. The damage in terms of lower exports had been set in motion when the rupee began to fall in 2018 with the change in government. Similarly, the problem with the Balance of Payments started to get out of hand and the state of the economy began to deteriorate.

Following that, the country implemented contractionary policies. To combat inflation and attract foreign money to manage FX holdings, the interest rate was increased from 6.5 percent (in May 2018) to 13.25 percent (from July 2019 to March 2020), followed by a Covid-19 reversal. After July 2019, the government began implementing the IMF’s expanded strategy, which includes lowering subsidies, hiking energy and petroleum costs, and raising interest rates, etc.

Slow economic growth, high inflation, a decade-high interest rate, and rising energy prices have all contributed to higher production costs, lowering any supposed gains from impulsive devaluation. The private sector’s ability to simulate economic development and increase investment has been limited as a result of the high interest rate.

Any benefits of depreciation in recent years were outweighed by the economic downturn and rising production costs. Overall goods and services exports in FY20 were $ 28 billion, down from $ 30.62 billion in FY18 and $ 30.22 billion in FY19, according to data from the State Bank of Pakistan. Despite the depreciation of the rupee, Pakistan’s exports fell in 2020, which is testament to the fact that there is no link between the two.

Copyright Business Recorder, 2022