Over the last four years, since PPP government has taken over, the value of rupee against the US dollar has depreciated cumulatively by 30 percent. At the end of third quarter of FY 2007-08, the price of one USD was 62 rupees and now at the end of second quarter of FY 2011-12 the price of 1 USD has reached to 91 rupees. With debt servicing, lack of external aid, dwindling reserves, import payments, the pressure on rupee is expected to continue.
The pressure on rupee is continuing and no serious measures have been taken yet to control this depreciation. If the pressure on rupee will continue then the rupee will be depreciated to around rupees 100 to a USD at the end of 2012.
The main culprit behind this huge depreciation of exchange rate is widening of the current account deficit during the period mentioned above, because of the large trade deficit due to higher demand for imports and rising oil and other commodity prices in international markets. In addition, financial inflows and foreign capital also kept declining due to deteriorating law and order situation in Pakistan and global financial crisis.
On the other hand, the cost of doing business in Pakistan is also increasing due to this depreciation and it is also badly affecting the manufacturing, industrial, and agriculture sectors of Pakistan as the country has to import fertilisers, oil, machinery, and industrial raw material. Although the weaker rupee has given benefit to exporters, as they are earning more, but this benefit is neutralised by the costly imported inputs of manufacturing sector, including textiles.
The impacts of this sliding value of rupee can be classified into three main segments: first is the higher price of imported goods that households have to face, for example the higher cost of food imports and the higher cost of fuel imports. If we talk about oil import payments which are being paid in USD and make up about 40 percent of the total import bill, they are increasing the pressure on rupee. Oil imports have increased to $6.299 billion from July-November 2011, compared with $4.237 billion in the same period last fiscal year. Furthermore, the oil import bill is likely to increase because gas crisis is now forcing factory owners to run their business on oil.
Second impact is the higher cost of import burden for the industries, so the industries that import lot of raw material as well as machinery from abroad now have to give a higher price for imports.
Third is the rising cost of debt burden which of course is linked with whatever the rupee value internationally is, and if this cost of debt servicing goes up, this actually implies the greater burden on the coming generations as well. The depreciation of exchange rate not only contributes to the surge in public debt but also it is inflationary by definition and it has also multi-dimensional adverse impact on economy and on people. I had explained in my previous article that the sharp depreciation of rupee had contributed to the rise in public debt as this depreciation alone had contributed roughly 1.3 trillion rupees of debt.
Given the current fiscal situation of the country as the government continues to finance the loss-making public sector enterprises and also continues with untargeted subsidies, the State Bank of Pakistan as well as commercial banks come into picture where they need to finance the government’s borrowing requirements. Once the banking system of the country mortgaged to the government’s needs, it squeezes the financing that would have been available for private sector as well. Now the additional inflation that gets created because of existence of extra money in the transmission channel, not only creates a price hike domestically but also puts the rupee in pressure vis-à-vis other currencies.
This in turn has two impacts: first it makes imports expensive as we know almost 60 percent Pakistani exports have in imported context, that have repercussion on exports particularly of industrial sector and secondly it makes existing debt stock more expensive.
Stabilising the currency and making an effective strategy to control this depreciation policy makers have to focus on growth reforms, supply side measures and expands its production particularly in case of export oriented industries. One does not expect the currency to be safeguarded otherwise, it has to be the focus on productivity that will actually safe the currency in future. So, Pakistan needs to improve fiscal framework not only to stabilise budget but currency also which runs the risk of going into a free fall.
Pakistan needs to look very closely at two things, first at the Euro zone debt crisis which will have its impact if it is prolonged, second at the related fears about a double depreciation. Pakistan’s economic managers must keep very close eye on both of these international trends which can in turn translate into falling exports for Pakistan, falling aid inflows, foreign investment inflow. In case both these crisis prolong, they will make adverse impact on the currency.
The debt repayments will put further pressure on rupee as Pakistan will have to repay $2.5 billion to international lenders in the coming six months, including $1.2 billion to the International Monetary Fund (IMF) in February this year. So, let’s see the policy makers will make an effective policy and implement it in time or not to save the currency.
The writer is a consultant at SDPI and can be reached at firstname.lastname@example.org
This article was originally published at: The News
The opinions expressed in this article are the author's own and do not necessarily reflect the viewpoint or stance of SDPI.