Interest rate/CA deficit: Experts call for ensuring prudent currency management

In the context of Pakistan economy, the direct relationship between interest rate and currency has been weak to moderate, which means that to play with interest rate to manage the currency is at best moderate but it could be safely assumed as weak looking at the relationship between the other elements of the current account, said experts.
Therefore, they said, this can be safely assumed that interest rate adjustments have minimal impact on swaying the current account deficit. Having said that, this must also be kept in mind, however, that the movement of policy rate remains a strong indicator and message for the market on where the policymakers see the economy going, but using it as a tool to manage the trade/current account deficit remains feeble.
To evaluate the impact of monetary policy, these experts have plotted trade date for the 20-years and compared it with interest rates and exchange rates during this period to figure out the correlation between country's political and economic dynamics and other realities on the ground.
They said the outcome of this drill has been absolutely fascinating as it has predominantly been off the conventional economic principles in a perfect environment or in more developed economies. Furthermore, the change in the relationship of various factors under assessment over different timeframes have also been very interesting, particularly the last 10-year period which has been a true outlier, probably due to political reasons. However, the most authentic of the chronologies seem to be the two decades one, as it has appropriately covered different sorts of events in different time periods. Hence, the requirement for necessary shift in the thinking and the strategy of policy-makers to manage the much-needed present current account deficit at hand.
They said neither interest rates only or exchange rate in isolation nor they both put together can address the acute challenge of the prevailing current account deficit. With a very large grey-economy and the substantial funding needs of the government being met from the market (and becoming a dominant borrower), renders monetary policy actions compromised and help in managing the situation to any extent only. There's an obvious need for strong support of supplementary measures on the fiscal front to stretch the shelf-life of monetary policy tools and finally need the most difficult structural changes to address the issues on sustainable basis. All these factors, monetary policy, fiscal policy and structural adjustments must move in tandem (or at least in a strategic, synchronized fashion) to get the full benefit of these available instruments; any of them run independently will have compromised results.
Regarding the influence of exchange rate to manage the trade deficit, they said the relationship between exchange and exports is strong. However, given the fact that Pakistan has wide trade deficit and there clearly seems to be no relationship between the exchange rate and the imports; therefore, there's hardly any correlation between the exchange and the current account deficit due to very large number of remittances which could be impacted with the change in currency conversion rates.
They further pointed out that our remittance are largely consumption-driven, the flow of the currency would remain indifferent to the exchange rates, as such. Therefore, Pakistan should use the currency adjustment with extreme care, given its influence on managing our trade deficit. It seems that with stubborn imports (essential items, high-end consumer products, etc) and narrow, low value-added exports; at times the exchange rate movement does more harm than help. However, like interest rates, currency adjustment remains a strong messaging instrument for the market on the state of the economy.
These experts have advised the decision-makers to make a decision to adjust the exchange rate and interest rate with extreme caution to manage the pace of the economy and the management of foreign exchange reserves through trade.
They have resolved that in order to manage the imports, the best instrument available is the fiscal policy (duties, cash margins, bans all together, etc.) at this stage, while simultaneously working on the import substitution, a medium to a long term fix. On the other hand, they added, the sustainable growth in exportable flows could only be achieved through a medium to long term solutions with structural changes (value-addition, non-conventional exports, etc) and exploring new paths, like manpower exports-an area gravely neglected-which must be given the status of an industry and measures must be taken and offer incentives, accordingly.
We are sort of left with medium to long term solutions, other than the aggressive fiscal measures, while all other actions, particularly the monetary policy ones, are a temporary respite and may act as a ventilator for the economy and may not be beneficial in the long haul, they added.