There is big debate going on these days on how the Pak Rupee is overvalued and why it should be devalued to help exports and to discourage imports; especially of luxury goods. Pakistan’s trade deficit has never been larger, posting a growth of nearly 138%, period on period (first fiscal quarter) – and this gap is now looking increasingly un-sustainable, especially in the wake of country’s dwindling exports. The main component of our exports, textiles, has been declining at a double-digit rate for most part of the year and other than services almost all sectors – rent seeking aside – appear to be uncompetitive when compared on the respective global corresponding-price scale. With pressure on foreign exchange outflows likely to increase in the coming months: external debt repayments, firming up oil prices, rising imports and fast increasing corporate profit/dividend repatriation, the pressure on the rupee’s parity with international currencies is also increasing, in-turn leaving the investors and businesses in a quandary on how to function amidst this growing uncertainty on the rupee’s future.
The general belief in the air is that Pak government is artificially holding the value of the rupee and the moment it stops supporting it the rupee will fall rapidly, the extent though remains anybody’s guess. The IMF overvalues it by about 22-24%, private businesses quote a figure in excess of 15%, and the State Bank of Pakistan (SBP) inadvertently admitted in its own report that it perhaps needs to be revised downwards between 12% to 18%. This then leaves us with three fundamental questions: 1) Is the Pak Rupee truly over valued? 2) If yes, then should it be devalued? And 3) If so, then by how much? On the answer to the first question, the truth is that the position is a bit confusing for two reasons: First, while on one hand we have all the indicators on retarding exports, escalating imports and a growing level of un-competitiveness in general in our domestic manufacturing, but then on the other hand the reality is that despite this notion on an over valued rupee there seems no panic in the open (foreign exchange) currency market, for example, the daily trading in buying and selling of dollars in the open market continues to remain normal. As a student of economics, if one believes in free market forces to be the real determinant of a product’s true value, then why question rupee’s present parity? After all, it retains its parity in the open market at around 107 (to a dollar) with no apparent panic or beeline for hedging (dollars) nor any shortage of the green back’s availability – and this, despite the ripe rumors on an imminent devaluation; SBP’s dwindling reserves; fast approaching payments on external debt; and with no cap on profit or royalty cum technical-fee repatriation by foreign firms. Second, history tells us that in today modern day economy governments no longer have the luxury to sustainably hold national currencies at artificially desired levels. The infamous Soros run on the Malaysian Ringgit exposed the myth of even thriving (with high foreign exchange reserves) economies’ ability to preserve currency values once the market confidence erodes. More recently, we have seen that in spite of having relatively high foreign exchange reserves countries like Turkey (around $80 billion), Nigeria (similar $70-80 billion) and Egypt (close to $60 billion) were unable to arrest currency slides once the global and domestic confidence in the government and its policies dipped. So, if these countries with foreign exchange reserves much higher than that of Pakistan could not hold the value of their currencies, then what makes us think that our government can, even if it wants to?
To come to the second question on whether or not the rupee should be devalued to boost exports, there exists no empirical evidence to establish correlation of devaluation with sustainable growth in a country’s exports. In fact, on the contrary, countries that have been associated with achieving exceptional success in national exports have all done so in periods where their respective currencies have been stable; the story of climbing the value added chain also comes across as being no different. Now it is altogether another argument where western economies allege that in China’s case, during this period of a stable Rinminbi, it was nearly 40% under valued to start with! However, the larger argument perhaps is not to see devaluation as a recipe to enhance exports, but as a tool to address competitiveness and promote manufacturing, arguably the most important element of exports. Joseph Schumpeter (the management guru) explained this beautifully back in 1942: The joy of birth can only be achieved if a baby is born to yourselves and not merely to your neighbor or to someone else in the community (this with reference to domestic manufacturing) and the best thing you can do for your child is to make him compete in the real world and not just pamper him in the four walls of your home (and this in reference to competitiveness & exports). And lastly, there is the classical argument on the responsibility of governments to provide a level playing field at home. Meaning, if your competitors have devalued their currencies you are left with no choice but to follow suit. A cursory look on the list of our competition and one finds that over the last 3 years in a like-to-like comparison to the devaluation of the Pak Rupee itself, China has devalued more than 8.50%, India about 5% and Vietnam about 3%.
Finally, to the last question that what should be done? Sadly, poor governance in recent years has brought us to a point where our choices are limited. If the Rupee looses its value, for every1% devaluation, the stock of national debt (local and foreign) goes up by approximately Rs310 billion. This in turn damages other macro economic indicators, negatively affecting financial management of the government. Secondly, during the last 4 years, the Ministry of Finance in an effort to support the Rupee, has asked government and semi government entities to take dollar loans to pay off their imports (Foreign Exchange import loans, rather than buy dollars from the interbank market). The inventory of current such foreign exchange loans is estimated to be around US$1.8billion. Any devaluation of the Rupee means a direct and proportionate hit on the P&L of those entities, which can cause a material hit on profits. Lastly, most of our imports are inelastic and any devaluation of the Rupee will cause the economy to import inflation, which in turn will increase reported inflation numbers. To counter this, the economic managers will have to increase interest rates. And since the Government of Pakistan is the largest borrower, any increase in interest rates will have a huge impact on fiscal deficit and Government’s ability to manage its finances going forward. So any devaluation not only needs to be gradual but also supplemented by other measures in order to avoid using it as a solitary tool to address issues confronting domestic manufacturing.
The writer assesses a cost-of-production differential of about 10% with our regional competitors and recommends the following: Devalue currency by about 7% over the next 4 months; Provide additional 3% incentives to exporters in shape of outright rebates, albeit through the banking channels (not FBR); and abolish all unrelated surcharges from the power bills of the industry. Not only will this be a small cost to pay to retain home grown foreign exchange inflows, but also save us a great deal of future pain on account of capacity closures and unemployment - markets once lost can be difficult to recover.