Daily Times

The exchange rate of any currency is supposed to be determined by the foreign exchange market. However, it has become a routine for the central banks to intervene in foreign exchange market to influence the exchange rate of a currency in order to obtain certain economic objectives. Notable examples include China and Russia. Both of these countries have deliberately kept their currencies undervalued in order to maintain a competitive edge for their exports. Similarly, economies that are more reliant on foreign direct investment (FDI) have an incentive to keep their currencies overvalued.

State Bank of Pakistan (SBP) also engages in this practice to maintain the exchange rate of rupee by using both conventional and unconventional tools. In the conventional way, it enters the foreign exchange market by either buying or selling dollar to manage rupee’s exchange rate vis-à-vis dollar. Recent stability of rupee exchange rate within Rs.104 — Rs.105 per dollar during the last two years is achieved through unconventional means in which the footprint of the State Bank of Pakistan is not visible. The State Bank of Pakistan gives phone calls to treasuries of commercial banks to direct the positions they can take either against or in favour of rupee. The reason for employing this unconventional approach is to give the impression that the exchange rate of rupee is determined by the market forces of demand and supply.

Rupee’s stable exchange rate during the last two years has come under serious criticism by academics, public policy practitioners, and even by our creditors like the International Monetary Fund (IMF). It makes sense too, since Pakistan’s capacity to earn foreign exchange through exports is diminishing while its import bill is hitting record levels each month. Despite market pressure to depreciate the rupee, the State Bank of Pakistan has adamantly kept it overvalued for the last two years. The directions have mainly come from the Ministry of Finance because Finance Minister Ishaq Dar is obsessed with a strong rupee. In the absence of State Bank’s support, the exchange rate of rupee will slide to a more rational level.

This is exactly what happened last Wednesday when the State Bank of Pakistan withdrew from its practice of influencing the exchange rate of rupee though its unconventional way. Panicked and confused, the treasuries of commercial banks started taking their independent and rational positions against rupee. During the inter-day trade on that particular day, the exchange rate of rupee went to as high as Rs 110 per dollar.

The depreciation was welcomed by domestic investors as KSE-100 index increased. An over-valued rupee was rendering Pakistan’s exports uncompetitive in global markets. It was expected that a depreciated rupee would give boost to Pakistani exporters. But less than 24 hours after rupee’s depreciation, rupee came back to trade at Rs 105 per dollar and a new governor of State Bank of Pakistan was appointed. Finance Minister Ishaq Dar, who has technically no business in such matters, took notice and launched an inquiry.

The rupee’s stable exchange rate during the last two years has come under serious criticism by academics, public policy practitioners, and even by creditors like the International Monetary Fund

It is surprising that no economic explanation was accorded to the event by mainstream commentators. In fact there was no economic explanation at all. Nothing at the economic front could justify such swift depreciation of rupee. The only explanations that followed were wrapped in political colors.

Pro-government quarters branded the episode as conspiracy against Pakistan while anti-government quarters considered it a ploy by the government to make it clear that the impact of the investigation against the Sharif family is going to be negative. Why such political hoopla around the depreciation of rupee exchange rate which is an economic indicator and not a political indicator?

The fact is that rupee exchange rate has become more of a political indicator rather than an economic indicator.  It has become a barometer against which both ruling and opposition parties compare the performance of the government. Even an average Pakistani views it as such. This has given an added incentive for successive governments to tamper with the de jure independence of the State Bank of Pakistan to micro-manage rupee exchange rate for their own political leverage. This is clear from the political appointments of the State Bank governor during the last decade. The most recent appointee is also purported to have close ties with the Sharif family.

The exchange rate of rupee should depreciate to its true market determined value. It is in the wider interest of the economy as a depreciated rupee may reduce Pakistan’s current account deficit which is currently at record high level.

We can’t expect this to happen as long as the rupee exchange rate remains hostage to repeated politicisation and continues to be viewed through political lens by the Pakistani public.

The writer is a researcher and works in the development sector of Gilgit

Published in Daily Times, July 14^th , 2017.