Are we subject to decimating the aggregate demand to reset the economy? The pricing adjustments are taking place more than required. The Real Effective Exchange rate (REER) clocked at 90.6 –down by 6.7 percent in one month. The number was 124.21 in Nov 17 and is adjusted by 27 percent since then, and interest rates increased from 5.75 percent to 13.25 percent – an increase of 2.3 times.
Where will this stop? How much more is required to curb demand? Well, it is not just about compressing demand, the objective is to attract foreign saving and domestic undocumented economy to the domestic banking system, and to lower the current account deficit. The undervaluation in currency, stock market and mouthwatering interest rates are to attract investment – mainly short term, at the cost of suffocating the economy.
A risky approach. The currency adjustment in June surprised a few as the REER adjustment and PKR depreciation against USD had a one to one relation on monthly basis. The nominal effective exchange rate (NEER) moved down by 7 percent in just a month. This implies that inflationary consequences of currency depreciation to date proved to be less than the impact of currency adjustment.
This was bound to happen. This space highlighted it back in Dec17 when the first round of currency depreciation took place. The argument presented back than was that the impact of currency depreciation in 2018-19 on inflation would be much less severe; as in 2017 food, petroleum and fertilizer prices were at premium to international prices, while those were at discount in 2008. For details read “Impact of currency depreciation”, published on 14th December, 2017.
The room to adjust was there till the equilibrium (around USD/PKTR 145-148), the absorption of currency depreciation was ample. The CPI clocked in at 7.3 percent in FY19 versus 3.9 percent in FY18. Now the economy is exposed to any price adjustment. And any further currency depreciation could have adverse inflationary consequences. Already the adjustments in currency post May 19 (Average USD/PKR 146.1) may bring some inflation home in months to come.
The other inflationary consequence would be of new taxation measures and hike in energy prices. The word of caution is required for Raza Baqir and Hafeez Sheikh to not get carried away in quest of building reserves and NFA by being totally inconsiderate to local economic realities. It is high time to pitch foreign portfolio investment and to fetch money from international capital markets by issuing Euro bonds and Sukuks.
The currency is adjusted enough, and the interest rates are too high. The reset button to economy has been pressed. The spree of documenting economy is in full swing, and FBR under Shabbar is bringing the untaxed into the net. An economy where significant chunk is informal, the shift will be painful for many. And that pain is in addition to currency and interest rates.
Recently, the architects of new economic paradigm were in New York to conduct road shows for selling distressed economy to investors. This has to yield results soon. What if the investors demand ‘do more’? Well, don’t ask this question.
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