If a central bank is indeed independent, then what is the primary job cum responsibility of its Governor? Answer: To defend the national currency by ensuring that it is traded at its fair value, as everything else, like controlling inflation (through monetary policy), regulating financial institutions, etc. is secondary. So, again going by the assumption that the State Bank of Pakistan (SBP) is also indeed independent, perhaps it will only be fair to ask its Governor the following questions: Was the recent devaluation necessary and if yes, then (as per his vision) by how much? Is the downward revision in Rupee’s value based on some fundamentals or is purely need or sentiment driven? If based on some fundamentals then what short-term and long-term measures is the SBP proposing to stem this parity slide and if based on the latter, then what measures does the SBP plans to adopt in order to mitigate this risk cum uncertainty, at least in the short-term? Never mind the answers, as not only one doubts that they will be forthcoming, but also because there is no visible institutional history of a transparent decision making mechanism for currency adjustments prevalent in the relevant quarters – whim of the finance minister in the saddle generally rules the roost!

Still, what is of paramount importance for the government is to somehow give confidence to the people that there truly exists an exchange rate policy, which is not merely driven by market sentiment or borrowing compulsions. This confidence in the coming days would be necessary cum important for the government itself to manage the frequency and the size of the inevitable depreciations yet to come in the value of Pak Rupee. Exchange rate, as we know, is the key price that links an economy with the global market. This linkage becomes distorted or is even disconnected for two main reasons: If the price of our national currency is too high, then foreign economies find it expensive to do business with us and if the price is too low, then it becomes expensive for the domestic economy to do business with the rest of the world. In addition, an excessively undervalued currency not only retards investment, growth and employment generation, but can render domestic manufacturing uncompetitive over the long run, as prohibitive capital costs become a barrier to industrial balancing, modernisation, innovation and value addition. So it is crucial for the policymakers to get the price right, especially if an economy (e.g. Pakistan) is too small to affect world markets. In theory, the fair parity should be determined by factors affecting demand and supply of the pair of currencies, say in our case the Pak Rupee and the US Dollar. However, putting this principle to practice is a rather complex process, especially in developing economies where markets are not fully developed and sheer perception and sentiment can play a significant role in altering the currency’s supply and demand in the open market. So how do we know if the price (exchange rate) is overvalued or undervalued in economies such as Pakistan? Theoretically, a much-used way is to chart out the trend – over 5 years or longer - in the real effective exchange rate and then see if the actually prevalent real effective exchange rate is above or below the estimated trend. Consequently, if the prevailing level is above the (equilibrium) trend, the currency can be considered overvalued and likewise, undervalued in the opposite scenario.

But governments such as ours that have to balance so many other political and security considerations that come as a part of the overall package associated with Pakistan’s economic management invariably find themselves difficult to simply stick with theory. Meaning, managing the exchange rate gets to be a tricky business in small yet fairly open economies like ours and hence requires utmost care. In essence the choices are rather limited as more often than not, nearly every government in Pakistan finds itself essentially managing only the frequency and the size of inevitable depreciations.

And this takes us to the most important question that what then really should be our policymakers’ vision in managing the Pak Rupee’s parity? The answer to this is two folds, short-term and the long-term. In the short-term, it is important to note that the longer the actual real effective exchange rate remains over the equilibrium trend, the more anxiety it creates in the markets, which eventually leads to big undesirable depreciations. It is, therefore, necessary to reduce the length of the cycle by resorting to gradual but timely policy measures to keep the volatility in the currency market in check. Doing so successfully does not only clear the air of uncertainty in the markets, but is also essential for keeping the external sector close to the equilibrium, at least in the short-term. To come to the second part pertaining to the longer-term and ascertaining whether or not the currency’s devaluation actually helps in structurally balancing an economy by boosting national exports and by making it easier for the foreign companies to engage with it, surprisingly, there exists no empirical evidence to establish any tangible 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! Also, the stories of countries climbing the value added chain come across as being no different. Of course the argument of some western countries notwithstanding, where they allege that in China’s case, during this so-called period (two decades) of stable Rinminbi, it was ironically undervalued by nearly 40%, to start with; but then again, it nevertheless remained stable! Importantly, the larger argument, which one must remember, is to not see devaluation as a recipe to enhance exports, but as a tool to temporarily address competitiveness in order to rekindle domestic manufacturing - arguably the most important element of boosting exports. However, let’s be very clear that over the long-term only a fair and stable value of the Pak rupee will allow the Pakistani economy to successfully take that transitional leap in becoming a truly developed economy that resorts to modern & cutting-edge technology and continuously climbs the ladder of value addition - There are just no shortcuts to ‘productivity’.

The writer is an entrepreneur and
economic analyst.

 kamal.monnoo@gmail.com