For devaluation, we do not need to have an implicit understanding with the International Monetary Fund (IMF). I am on record writing for the last four years that the rupee is overvalued and we need to adjust. Unfortunately, the recent adjustment in rupee was a forced depreciation.
It would have been much effective if we had started in 2014, and let the value adjust gradually. Pakistan must stop this policy of overvaluation – it has always hurt the country.
Previous governments have been borrowing to keep foreign reserves above and beyond certain level required to maintain a strong rupee artificially. On the other hand, an artificially overvalued rupee has increased imports to a staggering $57 billion with exports falling to $18 billion.
Pakistan needs to learn that borrowing for building up foreign reserves may help in the short-run but imposes costs as it did in the past.
At the same time, the maturity period of public debt, already piling up, has approached. The shortage of dollars has intensified as the capacity to supply dollars to the market was being squeezed, the pressure on the rupee peaked, and this led to the depreciation we have just seen.
Exchange rate stability has been confused with stabilizing at an overvalued level. The latter has serious costs. The longer it persists, the higher are the costs. Pakistan is witnessing some of these including worsening balance of payment, ever-widening trade deficits, and present fall of rupee in itself.
And this one bad policy compromises the efforts on other economic fronts. My view is the currency is depreciating because it was overvalued. One needs to clearly distinguish undervaluation from devaluation or depreciation.
Undervaluation means value of the currency is below its fair value. Pakistan rupee, based on present fundamentals, is in no way below its fair value. I must say, the argument that the fall of rupee should support exports is false in Pakistan for a very fundamental reason: gains from depreciation are based on a gradual adjustment i.e. planned depreciation.
Historically, Pakistan has always faced forced depreciations which has not translated into lower real exchange rates. Currently, let us also not forget that the State Bank of Pakistan (SBP) raised the interest rate and the government increased energy prices exponentially exactly when the rupee was falling. All these factors restrict the impact of depreciation on exports as their cost inputs rise.
The recent adjustment in rupee was a forced depreciation. It would have been much effective if we had started in 2014, and let the value adjust gradually.
The rupee fell, despite help from friends, countries lining up to commit money to Pakistan such as China, Saudi Arabia, UAE, Malaysia, etc., for at least three reasons. First, because the market knows that foreign reserves with the SBP are [due to] artificial backing on cash deposits from friends. Second, those deposits are finishing as they come. Third, minor adjustments in currency are [a] routine matter.
Moreover, the government and the SBP seem to have decided to let rupee adjust and not intervene in the market significantly for two obvious reasons. One, negotiations with the IMF are on and it is closely watching the currency market. This is limiting intervention in the currency markets.
Second, the government and the SBP have learned from the previous government’s experience that overvaluation for the longer term is not possible. It only exhausts reserves and then rupee dips. So they are letting it adjust gradually.
Pakistan needs to learn that borrowing for building up foreign reserves may help in the short-run but imposes costs as it did in the past. It is better to focus on the fundamentals of the economy.
Correcting balance of payment through bridging trade imbalances and controlling the budget deficit, creating an environment conducive for foreign investment to increase the FDI inflows, promoting remittances, and enhancing domestic investment, should be the key in this regard.
Dr Javed is a research fellow at the Sustainable Development Policy Institute (SDPI), Islamabad. He has been a consultant for the Asian Development Bank, the Islamic Development Bank, and the United Nations Development Program, Pakistan.