A devaluation of the currency is a decision to allow a currency, in a fixed or semi-fixed exchange rate, to decrease in value. Devaluing the currency means that the economies’ exports will become more competitive, imports should be more expensive. This should lead to greater demand for exports and an improvement in the current account. This is known as external devaluation.
In some cases, a country may be unable or unwilling to allow a typical devaluation of the currency, but they still need to improve their competitiveness. They may seek to reduce cost of doing business by, among other things, offering certain incentives in the shape of export rebate or by fixing the value of US$ at parity higher than fixed rate and imposing additional custom duties on imports. This is known as internal devaluation.
There is a widely held belief that devaluation of a country’s currency shall increase its exports, reduce imports and resultantly, improve the country’s current account balance. This belief is based broadly on 5 assumptions. One, the importing country was restricting the quantum of imports due to the high price of the said products; Two, the importer shall increase the quantum of imports by a percentage higher than the devaluation; Three, other competing countries shall not reduce their price by giving export-rebates or by devaluing their currency; Four, the input cost of the exported goods remain the same; Five, the exporter shall be able to arrange the enhanced working capital. And on import side, the basic assumption is that, the country’s imports are elastic and shall decrease due to higher prices; and reduction in imported goods shall be compensated by increased production of local goods which are equivalent or near-equivalent to the imported goods! However, the real world scenario is contrary to these assumptions.
There may be variations depending on the products and customers, but as a general rule, the devaluation has neither increased textile exports of Pakistan in the past, nor it is likely to increase the exports now
The assumption that at price X, a country which is importing Yquantity shall increase its import by a percentage higher than the devaluation. This assumption gives birth to another sub-assumption that the demand of the importer of the product at reduced price shall increase which may not be the case. It is also possible that our competitive countries may either reduce their price by either giving export rebates or devalue their currency or both. The other factor which the planners conveniently ignore is the input cost of local manufacturers. It is improbable that any country produces its exportable surplus without any imported input material or services. The more the imported input, the less shall be the impact on exports. Certain countries would have FTAs/PTAs and other agreements by which imports from a certain country would not be viable, even if cheaper, due to its being on the higher import tariff. It is also possible that the competing country, upon devaluation of its competitor, shall start giving export rebates equal or nearly equal percentage to its own exporters which shall not leave any room for the devaluing country’s exporters to compete in prices.
The imports may not reduce if the demand is inelastic like petrol, the demand of which shall not reduce due to its consumption in thermal generation and transportation. Same is the case of edible oil, demand of which is inelastic due to its being part of daily food consumption. And machinery not produced locally has to be imported for maintenance of current infrastructure or to expand it. Then the price of oil and edible may increase in the international market (due to reduction in production or increase in other countries demand) which may cost the same even if the quantum is reduced.
There are so many variables affecting the outcome of devaluation that you can actually write a book explaining what course the exports of various products shall take. However, let us see whether the devaluation has any silver lining for our dear Pakistan and its economy. I will dilate only on its effects on export of textile in general and garments in particular. Cotton is an international commodity which is traded at International Cotton Exchange (ICE) New York and is available at the same price in US$ or equivalent to every consumer in the world. In 3rd week of April, 2019, the cotton was quoted at ICE at US$0.7811per lbs which at US$/Rs parity of Rs141 works out to Rs 9,031 per 40Kg. The cotton price in Pakistan was then being sold @ Rs 9431 with a price differential of only Rs. 400/- which is due to freight factor. Let us take the example of a basic 5 Pocket Denim Jean. Major cost of any textile item is cotton which is available at par to everyone, anywhere in the world. The main components of this jean are fabric ( 50% of cost), accessories and packing materials ( 26% of the cost ,all imported material), chemicals and washing (6% of the cost ) and overheads including salaries, wages, energy, financial charges etc (18% of the cost). These percentages may vary depending on the apparel. This jean was being exported in April 2018 @ USD6.65 when the USD/PKR parity was Rs 115 which, in one year, has gone down to Rs141. This 22.60% devaluation increased the prices of yarn by about 17%, accessories’, being all imported/nominated, increased in cost by 21.74%, chemicals/ washing by 15%. The general inflationary effect on overheads was 18%.The sale price increased from Rs 765 per piece in April 2018 to Rs 886 p.p. in April 2019; increasing the rupee price by 15.78%. However, the importer paid USD6.28 for the same jean for which he paid USD6.65 last year; reducing the foreign exchange earring by 5.56 % for the said jean.
The data of Pakistan’s exports also substantiates my assertion. The official export figures show that in March 2018, the per garment export price was US$ 5.41 which declined to US$ 4.37 per piece in March 2019 indicating a price decline by 19.22%. The US$/PKR parity was Rs. 115 in April 2018 which was devalued to US$/PKR AT Rs. 141, by 21.60% —– almost the same as export price reduction per unit of garment. This working, more or less, is true for all garments and other textile items. There may be variations depending on the products and customers, but as a general rule, the devaluation has neither increased textile exports of Pakistan in the past, nor it is likely to increase the exports now. And what Einstein said about “doing the same thing over and over again and expecting different results.”
The writer is a Chartered Accountant and can be reached at [email protected]