Currency – The External Factor

2018-05-15T23:47:05+05:00 Dr Kamal Monnoo

With the change of government round the corner, do we have another currency crisis on our hands? Last time it happened at the advent of Zardari’s Government, in 2008, when the bottom fell beneath the Pak Rupee, devaluing it by nearly 30% within days. And if we do, then other than the external account follies at home, where else is it coming from? In Argentina, recently the central bank announced three separate rises in its target rates, each of at least three percentage points and that too in the space of a week. Its rates today are at an almost unimaginable level of 40 per cent as it attempts to defend its peso. In nearby Turkey, the lira is setting records as it continues to weaken and its interest rates continue to climb, in the process awakening national larger fears. The stories of Egypt and Nigeria look to be no different over the last six months. Pakistan itself not too long ago was grappling with interest rates as high as 24%. One does not need to be a student of economics or management to know that interest rates rise to such levels primarily on the back of currency devaluation and hyper inflation, creating an environment that erodes investments, hinders employment generation and enhances the pain of the common man.

While some may argue that examples of Argentina, Turkey, Egypt and Nigeria are not relevant, as the ones described are at best their local issues, but in essence such pressures in the developing economies are triggered from the developed world and Pakistan is also not an exception. For example, in 1994, tighter monetary policy from Alan Greenspan’s Fed pushed up yields and in-turn the rising dollars put an intolerable pressure on the Mexican peso resulting in a crisis there, later followed by a crisis in general in the emerging markets. In 2013, comments by Ben Bernanke about tapering central bank asset purchases spurred higher US Treasury yields and the taper tantrum pressed emerging markets. Result: They have underperformed developed world assets since! However, some may argue that such dynamics are not unique to the emerging markets. The desperate actions of Argentina’s central bank are reminiscent of the Bank of England on Black Wednesday. With the Pound under pressure from higher German rates, the bank raised overnight borrowing costs from 10 to 15 per cent during the day – and investors still kept selling the Pound. Meaning, one thing is clear, that such artificially high rates are not credible and when the chips are down they do little to help. And as a result a very high rate only increases the suffering of all stakeholders (government & the private sector), in the process making things even worse. The thing is that we need to look to the developed world, and especially the US, to understand currency weaknesses among a number of developing economies; mainly the ones with currencies closely pegged to the US Dollar (e.g. Pakistan). Right now we are seeing what experts describe as a delayed reaction to the election of Donald Trump. When elected, the fear was that he would quickly bring in protectionism and higher interest rates in the US. An expectation that resulted in hastening of asset sales by the emerging markets in 2017. However, these expected policies of his did not materialise in 2017, which when coupled with a surprise re-strengthening of the European economy in 2017 saw the weakening of the Dollar. This helped revenue inflows into the developing economies and their markets, despite originals fears, held up reasonably well in 2017. Things since in 2018 have changed.

Now, the US tax cuts have confirmed a belief that rates must rise, and Trump’s rhetoric lately has revived trade war fears. Meanwhile, in the first quarter ’18, Europe’s economy has gone off the boil (UK announcing its worst quarterly results in a decade). As a result, the US rates have risen, the dollar has rebounded, and Pakistan is back to the situation it found itself in 2016, albeit this time with an ever-widening trade deficit, fast maturing foreign debt repayments, and in comparison (to 2016) a much lower level of foreign exchange reserves. So what does this imply? The answer is that as long as the Pak Rupee remains closely linked to the movement of the US Dollars, it will remain a part of the larger pool of developing economies whose fate primarily lies in the United States (US). So, no surprise, that in the 4 months of 2018, according to JP Morgan’s EMBI index of emerging markets, their overall credit rating has fallen sharply, back to the level in 2016. Also, their foreign exchange index, as measured by JP Morgan has plumbed to its lowest level in 3 years. Remaining on Pakistan, what we need to take into account is that like all other emerging economies, our capacity to control foreign exchange flows is also very low and any significant flows of money displaced from the developed world are enough to swamp the Pak economy, or otherwise. So, a fair question that arises here is: that does this present a survival challenge for the Pak economy? Answer: Yes, of course since there exists a history of empirical evidence that developing economies, in good times, invariably tend to borrow more (in dollars) than their capacity and later tip over into a crisis when they are unable to pay their dollar denominated debt - this is precisely what is happening to Pakistan today - The dollar debt issuance in the last 5 years has increased (source: IMF) and we have been amongst the culprits.

This then takes us to the conclusion, that what then are the remedies? Unfortunately, nothing short-term, but in order to gradually come out of this trap and to ensure that we insulate ourselves for future such shocks, the policymakers need to reflect back to the pre-2005 days, when balance of trade was still closely controlled and not everything was accepted merely because it aided globalisation. It took almost 20 years (since the western raid on their currency markets) for the Asian Tiger economies (China included) to build a deeper pool of respective local capital whereby they not only overtly de-linked their national currencies with the USD, but also very prudently played the game of free global trade while cleverly disguising their commitment to safeguard home manufacturing to ensure churning out trade surplus year after year. Not surprisingly, the west today has woken up to this reality, and the recent wave of protectionism that we see emanating from the yesteryear champions of free trade, US & Europe, is nothing but a reaction to finding themselves on the losing side of the trade equation for too long. Unless industry stays at or comes back to home, no amount of foreign debt (CPEC, etc.) will provide sustainable guarantees to growth and prosperity. The real question though is that when will we realise that real solutions to our problems can only be found by looking inwards and not outwards?

 

The writer is an entrepreneur and economic analyst.

kamal.monnoo@gmail.com

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