Navigating exchange rate labyrinth

Classical economic theory of demand and supply for goods applies just as well to a currency, the Pak rupee, the dollar or any other. The demand for the Pak rupee is the sum total of the world wanting to buy Pakistani goods and services.

So the demand equals our exports of goods and services. In services we should also include the labour of all our workers, professionals or citizens abroad who support some family here or wish to invest in our country. To put it simply diaspora remittances. The supply of the Pakistani Rupee is the total of our citizens wanting to buy foreign goods or services.

So the sum total of imports of goods and services. The matter is slightly complicated by investment flows and profits, but these are not large in the case of Pakistan. If the supply of Pakistani rupee is larger than the demand for it then the value of the rupee will go on falling till the demand and supply for it balances.

This is just like say, the supply of footwear, if there is shortage then the price will go up, enticing the manufacturers to increase production and so increased supply will eventually strike a balance with demand at a higher price. Students of economics are taught this essential demand and supply equation in Class I. Unfortunately, most of our rulers are still unaware of this basic principle of economics.

So they go off on hair brained schemes to force exchange rates against market forces to achieve quick results. So let’s say if the rupee-dollar parity is fixed at Rs160 to a dollar, as being suggested, we would be faced with an interesting situation. The rupee price of imports will fall by 10/15 percent from their current costs.

Similarly, the prices received by our exporters in rupees will also fall by the same margin. This will obviously make imports far more attractive and exports less so. Those manufacturers who can will divert production from exports to local markets. Some will make losses and be forced to shut down. Certainly, all will curtail production for exports.

The importers, on the contrary, will make more money and therefore increase imports. The exports will fall and imports will enhance. As a direct consequence the current account deficit (CAD) will widen further. If we have the funds to support such extravagance then of course this would be a good way of bringing down the general price level prevailing in the country, and it will break the inflationary spiral for a short period, anyway.

Any government which seeks popularity would love to embark on such a course. The fact is that the foreign exchange reserves with the State Bank of Pakistan (SBP) are about 10 billion dollars, all borrowed, and with the commercial banks are about seven billion dollars. Our foreign exchange deficit today is four billion dollars per month. It will widen further as the diaspora hold back remittances and importers rush to stock up. Within months the reserves will be gone and we will not be able to pay for our imports.

The standard answer by the holders of this theory is that they will ration the imports. So let’s examine what can be rationed.

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Import Data July-March                2021-22             2020-21       Variance +/-%
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Group                             Value $ (M)         Value $ (M)
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Food                                7,067,740           6,121,358               15.46
Machinery                           8,684,508           7,132,774               21.75
Transport                           3,367,401           2,010,355               67.50
Petroleum                          14,812,559           7,553,911               96.09
Textile                             3,499,678           2,786,576               25.59
Agricultures and
other Chemicals                    11,098,317           6,341,520               75.01
Metal                               5,011,915           3,621,379               38.40
Misc.                                 911,911             923,860              (1.29)
All Others                          4,423,072           2,997,611               47.55
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TOTAL                              58,877,101          39,489,344               49.10
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The biggest item on our import list is fuel or petroleum. So are we going to start rationing fuel? Do we give each motorist or motorbike owner, bus and truck driver permits for every month? Do we have such a superefficient system in place which can judge the requirements of all persons who use fuel? How does the regulator know whether I am taking a joy ride by the seaside or taking my child to a hospital? Who will check the black marketing?

The next two items in importance or magnitude is machinery and food. Machinery consists of imported items to enhance the productive capacity of our factories. Do we wish to ration that and stop the pace of development of our manufacturing sector? Machinery imports are currently bloated because the SBP lent money to industry at nominal interest rates to encourage them to invest in equipment, this to ameliorate the effects of Covid. It shall soon subside in any case. However development is all about fresh investments and to ration that would be self-defeating.

The next big item is “food.” Are we willing to ration tea, edible oils etc.? If so, do we have a ration card system in place? Should we not have a fresh census before we embark on a fresh ration card scheme? After all a ration card will have to be designed so we check the requirements of each household. Similarly for agriculture do we stop the import of fertilizer and pesticides? In the transport sector the glaring luxury of shiny new SUV’s could be stopped or made more expensive. However to obstruct the import of trucks and buses, small cars would be a folly.

The only item which could be compressed partially is “misc.” and “all others.” Here also there are rubber, tyres computers and telephones.

Frankly speaking, the best rationing system is the price mechanism. When an item gets expensive consumers try to cut back on its usage. The responsibility of good governance is to make sure the vulnerable sectors of society suffer the least when prices go up. So items of food in common use, like tea and cooking oils should be cheap and chocolates could be expensive. This can be done through the import duty and sales tax regimes. It is commonly accepted that food, medicines, baby articles and educational materials are lightly taxed. We should follow suit.

The case for promoting exports is already well accepted. Exports not only bring in the foreign exchange for imports but create jobs as well. The exports have been rising at a phenomenal rate of 24 percent per annum. No doubt if the world sinks into a depression, as feared, this pace may not be sustained. However, as the newly imported machinery starts to give results, our competitive advantage will also improve. To allow the current exchange rate to work its changes, it will need some more time.

It takes a few years for farmers and factories to change cropping patterns, and retool factories to expand production. As exports rise, not only of industrial goods, but also agricultural produce and IT services there will be a healthy effect on the economy and employment. A survey quoted by the Economist magazine (Feb 8th., 21) of the Indian economy stated that a billion dollars of export growth in industry leads to the employment of 400,000 workers.

Whether this figure is accurate or not, what is clear is that our industrial and agricultural exports are labor intensive. In industry it’s the value added textiles, leather goods, sports goods, surgical instruments and IT which will boom. We do not have steel, aluminum, chemicals which are capital intensive. In agriculture it will be the fruits, vegetables and possibly rice which will boom, not wheat oil seeds, corn or other basic crops. These are all labor intensive fields. Hence export growth will generate more jobs and will assist us in upgrading our skills.

More than a fixed exchange rate we need intelligent management. The SBP should step in and control speculators, but not try to obstruct the long term market trends. Some Far Eastern countries have purposely held down their exchange rates to promote their export and tourism sectors, and it has worked wonders.

The Chinese are the best example; their exchange rate has promoted Chinese exporters to dominate the world. I am not suggesting further devaluation but only stating that any thoughts of an artificial revaluation would be suicidal.

Copyright Business Recorder, 2022