The exchange rate challenge

It is interesting to see that as far as the economic priorities are concerned, there seems to be an unannounced consensus between most of the political parties. Both the PTI and the incumbent governments rushed to the IMF to seek support, and then do their bidding.

They all seek much the same economic goals; an improvement in the standards of living and the elimination of poverty through economic growth. All accept that rapid growth can come through improving exports, not only in industry but agriculture as well. Luckily, the IMF also agrees.

To achieve this we will have to adopt a consistent policy of export promotion. The basics of export promotion, and import substitution, is a conducive exchange rate policy. This leads to the first dichotomy.

Are we to seek price stability, through an overvalued rupee, or are we going to allow it to find its market based value? In the previous PML-N government the then finance minister was hell bent on keeping the rupee-dollar parity at 104 or thereabouts.

On one occasion as the market forces pulled the rupee down to 109 rupees to a dollar, the then Finance Minister got furious at a public function. He threatened the “hundi wallahs” and vowed to bring the parity down again.

He threw over a billion dollars into the market and brought it down for a few months. If you have the reserves you can resist market forces for a short time, but no one can buck them for long.

Even the Bank of England could not prop up the British Pound indefinitely and lost billions of pounds in the process, then had to cave in and float the pound and abandon the fixed exchange rate of two dollars to a pound.

Many of us feel that the exchange rate is a barometer of national pride. The higher the value of the Pak rupee the higher our self-esteem.

However, the direct result of an overvalued rupee is a relatively stable price level, as imports flood in and exports are hampered. However this can only be maintained if you have endless foreign exchange reserves, which we don’t.

We live on borrowed funds and the lenders will not wait forever for us to return their money. The previous PML-N government sought price stability as a priority. To achieve this a fixed exchange rate was a big help. As a direct consequence our exports became uncompetitive against our neighbors and were stagnant for ten years. The imports were booming and we had ever wider deficits.

The fact is that the real exchange rate of a currency is the one at which its supply and demand is in balance. To put it simply, the value of exports and the sum total of immigrant remittances must be about the same as the imports, the expenses of our foreign travels, plus payments against foreign investments.

If the current account is in balance then the rupee will be stable. Of course there are distortions due to capital inflows and outflows but these are not very large in Pakistan. We all know that the PTI government allowed the market determined float of the rupee and the Governor State Bank of Pakistan (SBP) repeatedly stated that the value of the rupee must be determined by the market forces, and not by the Governor State Bank of Pakistan or the Finance Minister.

So we saw the Pak rupee drop from the Rs104 to the dollar to 145, then 170 and finally to its current value of Rs185 to the dollar. Even at this value there is a huge current account deficit. However, the exports are rising at a healthy 24%. This rate of growth is one of the best we have ever achieved and if kept up for a few years may see us out of the current account deficits.

No doubt that the imports have risen even more rapidly than the exports. But this is due to special circumstances which should reverse themselves this year. The international prices of our major imports such as oil, gas, coal and cotton have doubled.

Prices of edible oils have more than doubled. Industrial machinery imports have also ballooned due to the large amounts disbursed by the SBP, as one time almost free of interest loans to promote investment during the pandemic. Frankly speaking, these were wise decisions and saved the country from the ravages of the Corona pandemic.

This bulge will pass through by the middle of this year and imports will normalize. The prices of energy, commodities, cotton, edible oils and wheat are at a historic high and cannot be sustained. So it would be advisable to hold course and not panic. The fresh investments will also benefit the economy and make our industry more competitive.

While there is every likelihood of imports falling the exports may not fall. The rapid increase may slow down but a fall is unlikely. No doubt a world recession is feared and that will reduce demand for our exports. However, the current rate of the rupee is such that we are price competitive against India and Bangladesh, our two main competitors.

Our current spurt in exports is also our exporters retaking some of the lost ground of the last ten years. This happened as we floated our rupee in the summer of 2019, making our exports price competitive. Six months later, the pandemic hit and India shot itself in the foot.

They shut down their cities and hence the factories and are still struggling to get back. We in the meanwhile encouraged our factories and other institutions not to shut down. The SBP gave soft loans to all firms if the recipient would use them for retaining their workers through the pandemic.

We hear that Ishaq Dar has suggested that the value of the rupee should be spiked up to Rs160 to the dollar. The argument being that cheaper imports will reduce the cost of imports and therefore the cost of inputs for our industry, including the exporting industry. The only major exporting industry we have, that uses imported raw materials, is textiles. While 40/50 percent of its cost is cotton, and if cotton is entirely imported then this argument would hold.

However, we produced about 10 million bales of cotton last year and will import about 5 million bales. Our textile exports are almost entirely based on Pakistani cotton as it is short staple, and trashy. The US and other imported cotton is longer staple and cleaner. It is therefore used to make the better quality lawns and shirting that are so liked in Pakistan.

The exports of IT, agricultural products, sports goods, etc., have very little import content. So a cheaper dollar will just make imports cheaper and therefore more attractive. This writer shall follow this article with another on what may be the likely impact on different sectors of the economy if the rupee/dollar parity is brought to 160.

To bring the rupee back to Rs160 or thereabouts to a dollar will need the finance ministry and SBP to throw a couple of billion dollars into the market. This we don’t have, and certainly the IMF will shy off. The only way we can feasibly prop up the value of the rupee is by bringing about a consistent current account surplus. This can be done by promoting exports and encouraging import substitution and that is through a free exchange rate policy.

Copyright Business Recorder, 2022