Daily Times

The recent panic on fall of Pakistani rupee showcased how deep rooted is obsession with strong rupee. But most importantly it denotes how robust misunderstanding of exchange rate is. It is robust to the extent that one finds leading dailies publishing material comparing fall of Indian rupee with Pakistani rupee and creating Turkish lira scenario for rupee. This is rooted in confusing planned depreciation, forced depreciation and financial crisis with each other.

Pakistani rupee plunged because it was overvalued artificially, not supported by fundamentals of economy. In India, it is more a transmission of Turkish lira and oil price rise effect. The lira fall, catalyzed by external factors like tariff wars, is rooted into treasury’s continued controlling of central bank of Turkey to not allowing adjustment of policy rates upward. This created artificial boom. Integration of Turkey’s trade with global value chains and US made tariff wars exposed Turkey. And Lira slipped. This is not the case for Pakistan. All three cases are incomparable directly.

Backed by poor exchange rate literacy in Pakistan, one finds compelling arguments about preferring borrowing-to build foreign exchange-over rupee depreciation. The proponents would tell you that 10% dip against dollar shall cause debt burden of rupee 800 billion, assuming public debt of US$ 80 billion. Alternatively, borrowing extra US$ 6 billion adds 650 billion rupee to debt. The debt burden of later is less than that of former. Advice, borrow more to protect rupee. This is what I call accounting understanding of exchange rate.

Artificially overvalued rupee promoted imports to staggering US$ 57 billion with cuts in export falling to 18 billion. It means inflow of dollars to country was far less than outflow of dollars. At the same time, maturity period of public debt, already piling up, approached. The shortage intensified. Capacity to supply dollars in market squeezed. The pressure on rupee peaked

Plagued by short horizon, this approach ignores the questions like-where will we pay the loans back from? How long will a country keep borrowing if supply of dollars dries? What will happen if debts pile up to peak and no more borrowing is available? And what are the other opportunities forgone and costs that the country has to suffer because of overvalued rupee?

These and many other similar questions demand an economic understanding of exchange rate which comprehends socioeconomic impacts of exchange rate fluctuations. Going beyond immediate one point debt burden impact, economic understanding takes into account medium and long run effects of variation in exchange rates which include saving, investment, inequality, trade balances, twin deficits, interest rate, inflation, economic diversification and productivity to name few.

The outgoing government actually adopted former strategy of borrowing for exchange rate overvaluation-building foreign reserves above and beyond certain level. This was done in the name of stability. Exchange rate stability was confused with stabilizing overvaluation. The later has serious costs. The longer it persists, the higher are 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 compromised the efforts on the other economic fronts.

Artificially overvalued rupee promoted imports to staggering US$ 57 billion with cut in export falling to 18 billion. It means inflow of dollars to country was far lesser than outflow of dollars. At the same time, maturity period of public debt, already pilingd up, approached. The shortage intensified. Capacity to supply dollars in market squeezed.  The pressure on rupee peaked.

The outgoing government, in its last year, was left with no option but to let the rupee fall. This is what I call forced depreciation. Gains from depreciation are based on gradual adjustment as a policy tool-the planned depreciation. Recent slide of rupee was forced fall which compromises gains. All factors together, the rupee plunged at quicker rate.

Sudden plunges create uncertainty. So did rupee’s. The uncertainty regarding next value of rupee created panic adding volatility to the rate. It made rupee trading over its fair value for the time being. Political instability and election campaign wherein one party was claiming doomsday for economy added their component as well. Many who consider strong currency a flagship of economy panicked on adjustment of rupee to its value adding more to uncertainty. Rupee traded at 131 on 23rd July.

Had it been a gradual adjustment, it would have gone almost unnoticed without and panic and the associated costs. Indian rupee lost to dollar by 26% since December 2013 which is slightly lower than 30% fall of Pakistani rupee to dollar over the same period. The later created dooms day scenario, while the former went almost unnoticed. This is difference of forced and planned adjustment of currency value.

Three years back from now, research at SDPI and many other independent experts reported fair value of rupee between 123 and 127. There were continuous warnings that you cannot sustain rupee artificially for infinite times when we have to pay more dollars to the world than we earn. One day or the other, it will dip. And it dipped. New fundamentals define new fair value.

Rupee strengthened back to its fair value on reports of US dollar 2.5 billion loans from china trading at 122 on 30th July, 4.5 percent in a week. IDB has also raised the limit of oil borrowing to 4.5 billion dollars. Perceived political instability, with incoming of new government, also factored in. The rupee, trading at 123 a dollar on 27th Sep, seems stable now

There are few important lessons we must learn. First, do not buy panic. The fall in rupee was long overdue. Second, do not play with monetary policy and do not play too long. Let the central bank take its route. Indian, Pakistan and Turkish experiences exhibit adversaries of poor monetary policy and underline significance of central banks’ independence to take decisions. Reserve bank of India stood the heat and let the rupee adjusted gradually, we did not. Rupee plunged steeper.

Third, exchange rate is not flagship of economic strength and that Pakistani rupee is different from lira. So do not fear financial crisis here. Fourth, persistent overvaluation is neither possible nor a prudent choice. That demand for dollars was more than that of the Pakistani rupee leading rupee losing to dollar. Fifth, rupee will dip yet again, if artificially managed. Sixth, it is not how much government allows rupee to adjust, it is more about how gradually does it plan the fall.

Most importantly, Pakistan need to learn that borrowing may help in short run but imposes costs as did in past. Better to focus on fundamentals of economy. Correcting balance of payment through bridging trade imbalances and controlling budget deficit, creating environment conducive for foreign investment to increase FDI inflows, promoting remittances and enhancing domestic investment shall be key in this regard.

The writer is Research Fellow and heads Policy Solutions Lab at Sustainable Development Policy Institute [SDPI], Islamabad. He tweets @sajidaminjaved

Published in Daily Times, October 11^th 2018.