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Sunday, April 14, 2024

SBP official explains “Why is the Rupee always depreciating?”

Because we are a consumption driven society, this itself leads to continuous trade deficit which causes depreciation

State Bank of Pakistan (SBP) has started a series of podcasts on different interesting topics. Topic of discussion in episode 3 was “Why is the Rupee always depreciating?” which is also the talk of the town these days.

Program host, Adeel Azhar began the episode with brief discussion about Rupee’s historical trend which showed continuous depreciation. He said, “If we generally compare developing countries then it is true that PKR is lagging behind a lot of countries.” Every country has its own economic problems just like Turkey. In case of Bangladesh and India, their currencies have also depreciated but not as much as PKR. However, Sri Lanka is an outlier where the currency depreciated to exceptional level due to their own current account problems.

Read more: Pakistani Rupee dives into the sea

Dr. Ali Chaudhry, Research Advisor at SBP was the guest who began his discussion with an interesting experiment with the host for which he brought a $100 note and 22000 Rupees. He asked about his preference from both the currencies, and the host immediately chose the dollar note. He kept them aside and said that its not only you, but same thinking also prevails in majority of Pakistanis.

He himself raised a question, “where does the USD come from?” Dr. Ali highlighted that there are two ways; through earning in USD either through exports or remittances, and if someone gives them to you as credit or gift. On the other side, we spend dollars by buying imports such as cheese, biscuits, machinery, raw material etc. Ups and downs in currency is due to the imbalance between these two.

He elaborated, lower imports cause depreciation in rupee while increase in exports means more dollars in the country, hence appreciation in its value. He referred dollar to a commodity for which demand, and supply are the main forces, when supply increases and demand decreases it becomes strong. Other way round which is mostly the case of Pakistan is insufficient dollars which causes depreciation.

Adeel Azhar quizzed the guest that why aren’t we able to fix things?

In response, Dr. Ali stated that there are four main elements behind this continuous depreciation; first is inflation differential which is inflation in Pakistan relative to our top trading partner, US. Pakistan’s three major exports are leather, garments and rice. Prices of these commodities have increased by more than 200 percent since 2006. In comparison, prices for same commodities increased by 13 percent in US.

He stated that something needs to equilibrate these two so that we can export these commodities. Depreciation is the way to allow a foreign consumer to consume our commodities as it causes an increase in their real income.

Hence, in order to improve competitiveness, depreciation occurs.

The host added that it is like a “downward spiral or a vicious circle” from which exit is not possible due to increasing inflation. He then inquired; how can we escape from this downward spiral?

In response, Dr. Ali talked about productivity growth for this matter. Same factory either produces more goods or lesser number of people produce more which results in cost saving and price reductions. As a result, we will be able to offer cheaper products to the world.

The problem is, if we compare our productivity growth with our competitors, Vietnam, Bangladesh, Philippines, Indonesia, it is much lower than any of those countries. He emphasized that is due to the lack of long-term productivity policy.

The host brought to the table that people prefer imported goods instead of Pakistani goods due to quality issue, which is surely a challenge. To this, Research Advisor replied that in Pakistan there is very less trend of saving and people are inclined towards more consumption. To meet that demand, the country does not produce that much and hence import. Moreover, from the perspective of imports, they keep on increasing and exports do not increase at the same pace. Ultimately, we go to seek assistance either from the IMF or bonds market where interest rate is so high.

Dr. Ali Chaudhry depicted a direct relationship between consumption and trade deficit as consumption increases, trade deficit increases, which causes depreciation. Because we are a consumption driven society, this itself leads to continuous trade deficit. Interestingly, trade deficit turned into surplus for not more than 1 to 2 years. So, we should not expect the currency to appreciate.

“Because we have love for consumption, we also have love for fixed exchange rate,” he said. It’s a result of several years not only one government over another. He added, “It’s been a perennial problem.”

He then brought those currencies back in discussion from where he began. Obviously, people can see the benefit of preferring dollar over rupees because it directly effects our consumption. “This is not a sustainable step because you run out of dollars,” he said.

The host then raised another question that “In recent times, there is such a big decline in Rupee value, what has gone wrong in last four years or is it some adjustment which our country is going through?”

He responded, after 2000, jumps in rupee are bigger. Firstly, larger is the deficit, larger will be the depreciation. If you go in depth of the deficit, then prior to deficit there is always some stability of the exchange rate and then there is a point we put all our effort to stabilize there. However, it depreciates in large amount to bring demand and supply in equilibrium. At times it gets affected due to sentiments as well but eventually trade deficits have the major impact.

Secondly, size of the economy is growing because population is growing and so is the size of trade deficit, perennial and increasing.

Thirdly, middle class is growing, in order to hit them, exchange rate adjustments need to be much bigger than that. He added, “any inflow that is not so organic (against what we have not produced anything), it slower down the adjustment of Rupee.”

Fourthly, regarding remittances, he said that they are also very helpful in the country, but they all create “Dutch disease effect”. Again, slower adjustment causes a blast in the end.

These are the four sets of explanations behind continuous depreciation of Rupee.

Next question was, what are the ways of coming out of this vicious circle?

Research Advisor said, “to get out of this, there is no silver bullet.”

He suggested the following measures:

  • Cut your coat according to your cloth. If you want to increase productivity, machinery will be required to be imported which we cannot produce in our country.
  • Bring Foreign Direct Investment (FDI) which is a long-term investment.
  • Promote portfolio investments.
  • Incentivize private enterprises to go beyond borders and make themselves sustain there.
  • Model of financing the current account deficit must change as in case of Pakistan, government brings in the new machinery. In case of Turkey, it’s the private enterprises which go abroad and self-sustain while bringing benefits for the country.

Last question being raised was, “Are the companies in our country in position to go and raise money in other countries?”

Dr. Ali responded immediately, “Yes totally! Ikea is in Pakistan; we do a lot of work with them. Khaadi is a big group they can go out, but they need to bring into this mindset that they need to become self-sustaining.” In this way, government can spend money on bigger projects.

He added that the way the Rupee behaves, if we move towards ‘so-called market determined exchange rate’ (at which we are right now) this will change our industrial approach. Now, our society is consumption driven but when things will change, there will be an outward looking industrial approach.

He then highlighted that management of debt needs to be improved. “Planning was not great, and we had to go to the IMF.”

He concluded by saying “stop looking at the dollar.”

To discourage this behavior, SBP has introduced a new law of price stability so that PKR becomes a proper store of value. PKR is not able to perform this function of money right now.  Price stability is the top priority in the new SBP Act. Of course, it will require time to be established.