Dollar’s appreciation vs rupee’s depreciation

The accountability drive in the country is in full swing. The deadline for the tax amnesty is not to be extended beyond June 30, 2019 as strongly pronounced by Prime Minister Imran Khan in his late night speech. The looters of the national exchequer are to face serious consequences. The Financial Action Task Force, while acknowledging the steps taken by the government to implement the action plan against money laundering, has asked the government to do more. The government claims to have presented a budget for the fiscal year 2019-20 that will take the country out of economic crises, later if not sooner. While the government should be appreciated for its unrelenting efforts to boost a nose-diving economy, what gets appreciated instead, is the US dollar.

On June 28, the US dollar reached its historical peak at Rs 164 per dollar in the interbank market. Economic pundits claim that the surge in the price of the US dollar is not to stop in near future.  In the past, the State Bank of Pakistan had intervened in the open market to control the increase in dollar price, however on June 16, Governor State Bank of Pakistan Mr Reza Baqir clearly laid out that the exchange rates in Pakistan would be market driven, which meant that the forces of demand and supply were to determine the dollar price and the State Bank’s intervention would take place only if there was “excess volatility” in the dollar rate. How volatile dollar will be in the coming days and how much volatility will be deemed as excessive are the questions that remained unanswered.

Mr Baqir further stated that neither a fixed nor a floating exchange rate regime was suitable for the country’s economy and he has a reason to say so. Those with basic understanding of the international monetary system know very well that a fixed exchange rate regime ensures exchange rate stability; however, it does so at the cost of monetary independence—a key factor that provides impetus to economic growth of a country. On the other hand, a floating exchange rate regime may ensure an independent monetary policy and economic growth but exchange rate stability will largely be ignored in such a currency regime. A market driven currency regime is the midway, but would it be the best way, only time would tell if we stood the test of time, which we hopefully will. State Bank of Pakistan with $14 billion in the reserves, has little margin available for stabilizing dollar rate and therefore it has good enough reason to follow market driven exchange rate regime.

SBP governor said that adopting market driven exchange rate regime was a part of economic reforms undertaken by the government. He also said that the tasks of the International Monetary Fund have all been accomplished. Quite an accomplishment and the governor surely deserve a pat on the back but that should come from the IMF and not from the people of Pakistan. Being a technocrat he would not care what the people think or say and would do what is technically correct, but then it is the political government that will have to bear the consequences of what technocrats will do. Mr Reza Baqir is a competent person and he can surely get another job without much commotion. However, in a sluggish economy, employment will be beyond the reach of millions of skilled and unskilled workers out there.

As for accomplishing IMF tasks, we need to take a look at what happened in Argentina by the turn of the last century. Argentina adopted Currency Board Arrangement (a stringent form of fixed exchange rate regime) in early 90s on the recommendation of the IMF. The political government accomplished the task set by the IMF and within a decade or so Argentina experienced a political and economic turmoil of the worst degree. While some may argue that the Argentinean economic depression favors market driven exchange rate regime, it also suggests that accomplishing IMF tasks does not automatically guarantee a successful economic order.

One good thing about market driven regime is that one can hope for the dollar’s rate sliding back, but then it is not for the first time that the depreciating rupee has been justified on the pretext of increasing exports—something real desirable for the economy. Increasing exports will help the economy in multiple ways. Besides bringing in revenue for the country, it will cut down the trade deficit and would accelerate the economic activity. We would need to produce more to export more and this will give rise to economic activity resulting in more employment. More employment will increase the disposable income of the households and eventually will bring economic prosperity. Easier said than done!

A depreciating dollar or appreciating rupee will hit our exports and therefore the dollar rate is not to go down. It took Japan half a century to bring its currency from ¥350/$ to ¥108/$ level without compromising on its exports. Due to cultural differences Pakistan will certainly take more time than fifty years to meet the same fate.

Increasing exports is a good objective, but we do not think of producing more, we do not strive for better quality, we do not take into account technological development, what we think instead is a depreciating rupee to increase exports, although we know that this will work only in the short run and is not a sustainable measure by any means.

Why dollar rate is constantly increasing? There can be more than one reason for that. But first it is important to acknowledge that ours is a rent-seekers economy. We, as a nation, have little interest in producing goods or services and we certainly have a passion to make more and more money as quickly as possible. Talk about investment and the avenues that would come to our minds will be stock exchange, real estate or currencies, rather than a production unit where goods or services could be produced.

Unfortunately, stock exchange is undergoing a slump due to high interest rates. The institutionalization of financial markets has decreased the stock market volatility, which is a good thing. But as a result of this the speculators do not find this market lucrative anymore. Real estate is also facing slump which is somewhat aggravated by the recent changes in capital gains tax. Now, one has to hold the property he has bought for ten years to get capital gains tax exemption– a bad news for speculators interested in quick money. The only investment avenue left is the US dollar which has been promising abnormally high returns in the recent past. The demand for dollars in a market driven economy will continue to increase as the speculators see an increasing dollar and potential gains coming out of it.

With State Bank policy rate hovering around 12.25 percent, there is little scope for any real asset investment and growth in production and service sectors of the economy. The increasing cost of capital as a result of high interest rates will make the most lucrative of the projects unfeasible. With electricity and other input prices increasing, increasing the level of exports will only be a dream unfulfilled. In the last quarter, the exports actually decreased by 1.9 percent despite a 16 percent appreciation in dollar value for the same period. Can we still justify an appreciating dollar as a measure to increase exports?

The increase in dollar has also reduced our imports by 4.9 percent and the government has a legitimate claim that it has been able to reduce trade deficit as a result of rupee depreciation. But some of the imports are necessary for the economic growth to take place like machinery, equipment, etc. which will become too costly with an appreciating dollar. Thanks to our Saudi brothers we are going to get fuel for the next three years on deferred payments. But then who will foot the bill after three years if the dollar’s surge continues and we find dollar to be at Rs 250 in three years time (God forbid!).

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