Pakistan’s exchange rate management
Exchange rate is one of the most important determinants of a country’s relative level of economic health. Exchange rates play a vital role in a country’s level of trade, which is critical to most every free market economy in the world. In our own country we can see that exchange rate behavior always remained uncertain thus always case of curiosity for investors and business community in particular and government while measuring the economic performance.
Thus when it comes to value of dollar in terms of PKR during the time period of 2013-17, dollar came to as low as 98 PKR per dollar and 110 PKR per dollar. During the period of 2013-14 when per dollar value came to 98 PKR, it was due to inflow of investment which helped shift market sentiments in favor of the rupee. State Bank of Pakistan (SBP) during that period received foreign direct investment of over $500 million with almost $107 million in January 2013-14 alone.
Similarly the expected receipt of $550 million from the International Monetary Fund (IMF), along with the launch of Eurobonds amounted to $500 million also led to positivity in the foreign exchange market. It was during this period till November 2017 per dollar value fluctuated in between 102 PKR and 105 PKR. Reason behind this stagnant behavior beside inflow of investment during 2013-14, also includes agreement between Pakistan and Afghanistan to trade in dollar. This agreement resulted in expected receiving of $2 billion per year.
Further during the years or so inflows along with certain activities which include restrictions imposed by Ministry of Finance and control by State Bank of Pakistan has led to this static rate of dollar to rupee. This below 100 PKR value of dollar in 2013-14 was also due to interventions made by ministry of finance. These interventions include legally binding all the transactions above 100 dollars to go under certain amount of fees which discouraged sending of money through hundi and havala which are prime informal sources of sending remittances.
With all these short term measures there was positive growth trajectory in the system with dollar remaining stable. Along with these short measures there was also oil price which also played its role globally in controlling the dollar value thus not hurting import bills of Pakistan.
But what went wrong in current days that dollar against Pakistani rupee is going up at a very high rate exerting pressure on Pakistani rupee. Before going into this debate it is important to note here that from 2007-8 till 2017 Pakistani rupee has devalued by 5 percent on annual basis. Key reason behind this devaluing of rupee is the pressure of payments on the external account and Pakistan’s high debt burden.
This currency devaluation would have at least two serious implications: 1). A sudden rise in the cost of debt servicing; and 2). Rise in the cost related to investment on imported capital goods, particularly for long-term infrastructure projects.
Further it is to note that with rupee getting weaker as far as second point is concerned adverse impacts are there on terms of trade and transfer of resources abroad which worsen the balance of payments position.
Different studies in this regard showed that trade and current account deficits have been a continuous problem and are being managed by workers’ remittances, ballooning foreign debt and fluctuating capital and financial inflows with worsening external sector imbalances. It is thus important to note here that rupee depreciation as different studies of exchange rate also suggest that it temporarily help in boosting exports by making goods and services cheaper for foreign buyers. Hence to cut imports by making them expensive for domestic buyer’s the external sector has to absorb certain shocks.
It is also important to note that with the imported capital goods and industrial inputs, including raw materials, becomes expensive as a result of rupee depreciation, the cost of production of exportable goods also goes up thus losing competitiveness. In case of Pakistan, it is also observed that costly imports have not encouraged enough import substitution nor have external sector pressures which could have convinced the country’s policymakers to mobilize increased dependency on domestic resources and reduce reliance on foreign money. Such problems have led to the trade and current account deficits by becoming perpetual problem with the external sector in a crisis.
So what needs to be done in order to allow State Bank of Pakistan to manage exchange rate effectively in the long run?
State Bank of Pakistan should be autonomous institute to control all the policies under its umbrella. By giving full autonomy it can manage the exchange rate by its own by looking both at the exogenous and endogenous shocks. With this autonomy in managing exchange rate, SBP can look into the demand and supply to print the dollars by looking at the International prices and interest rate.
With this balanced and autonomous State bank of Pakistan, disconnect in between the policies should be looked after as is in the case of trade policy and all policies for business community in which State Bank is directly involved. It is because of this disconnect there is much uncertainty within the existing business environment of Pakistan. This disconnect and uncertainty within the policies should be worked out by aligning each policy in accordance with the previous policy. This alignment will further help market including market forces to work in full capacity without undue pressure which will further strengthen the confidence of business community in the policies.
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The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.