Pakistan has seen steep devaluation of currency in last few days. Since December 2015, the rupee traded between a strict band varying between 104 and 105 rupees to the dollar. The State Bank withdrew its support on Friday, and currency had plunged down to be traded on level of 110.2 as on Thursday mid-day.
Such scenario has brought in risk of high inflation wave. As a rough rule of thumb, a 10% devaluation may increase prices by 2-3%. The components of the CPI most affected by devaluation are fuel and food items.
Historically world has seen that after a depreciation, we get; Imported product price increases without differentiation among luxury or essential items unless Government intervene. A large and rapid devaluation may scare off international investors and force them to exit the market.
While advantages of devaluation historically noted are that exports become cheaper and more competitive to foreign buyers. A higher level of exports should lead to an improvement in the current account deficit. This is important if the country has a large current account deficit due to a lack of competitiveness. Sudden 5.2% devaluation of Pak rupee, in addition to damaging investor confidence, will further challenge economy that is already facing risks arising out of political uncertainty, widening trade deficit, debt servicing pressures. While there were ongoing debates in recent months about overvaluation of Pakistan currency but that doesn’t mean that corrections shall be done in once go. A systematic approach of gradual decline shall be adopted in order to give fair play field to stake holder.
A more disciplined approach should have been adopted by State Bank of Pakistan through formal announcement of exchange rate. Such sharp devaluation has left currency dealers clueless about the reason, resulting in a panic. The State Bank of Pakistan (SBP) has released a statement, saying that the change in the exchange rate was completely natural and based on the demand and supply of dollars on the interbank market. If it was the case SBP should have announced in advance and should have taken measures to control it over next few days. SBP shall analyze the reasons devaluation in addition to take stiff measures to control undue speculations and malpractices in the operation of foreign exchange markets in Pakistan.
Such decline will add in to cost of doing business for industrial and agricultural sector due to negative impact on pricing of imported raw material as well as allied products like oil.
Further a misconception that this devaluation will be beneficial for exporters shall be addressed. It’s a myth that the weaker rupee benefits the exporters by giving them more rupees per dollar, but this benefit is neutralized by the costly imported inputs of manufacturing sector thus eroding the financial advantage of a weaker rupee. Further in order to hunt competitive pricing in International Market, traders start focusing on exports ignoring local demand, thus leading to local Inflation due to demand and supply gap.
Pakistan imports are currently standing at two times of its exports. This 5.2% devaluation will directly affect prices. Oil prices increase is inevitable and in turn it will affect prices of items in daily use. In past we have seen that increase in fuel prices have directly impacted price of fruit and vegetable, transportation and multiple other items of daily use.
Further the depreciation of Pakistani rupee will lead to a massive surge in Pakistan’s external debt and one rupee increase in exchange rate will add approximately some Rs 80 billion to the foreign debt and liabilities quantum in term of Pak Rupee. With 5.2% devaluation since Friday it has already dented debts by approximately Rs 420 Billion. According to State Bank of Pakistan’s (SBP) statistics with an exchange rate of Rs 104.9, the country’s external debts stood at Rs 8.330 trillion. With current Rs 110.2 exchange rate, in addition to increased interest the external debt will be calculated at Rs 8.750 trillion.
All aspects shall be analysed collectively to draw conclusions. Government shall intervene to fix the exchange rate to curb the effects of speculation as a first step.
The writer is a finance expert currently working as Country Finance Head with a Multinational Retail company, as well as non-executive director in First Capital Group Companies. He can be reached via [email protected] and tweets @JawadSaleem1982
Published in Daily Times, December 15th 2017.