Daily Times

The exchange value of Pakistani Rupee has been stable around Rs 104 per dollar for the last 13 months. This stability goes back even more than that. Rupee has been somewhat stable since 2013. Last time Pakistan had a stable rupee streak was during 2001-2007. Economic fundamentals crucial to exchange rate stability were strong then. Current account turned surplus for two straight years from 2002 to 2003. Net foreign direct investment was on a record high. These two factors translated into high forex reserves. The recent record forex reserve build-up is hard to explain given the low net foreign investment and a current account deficit that is deteriorating with each passing day.

While economic sense cannot explain the current buildup of forex reserves and the ensuing stability of rupee, political logic can. The roots of this stability lies in the $6.6 billion worth of International Monetary Funds’ Extended Funds Facility that was granted to Pakistan right after the Pakistan Muslim League-Nawaz’s government came back to power in 2013. Such loans are conditional, and one of the conditions is to push up forex reserves and ensure a stable currency. Every time a tranche of that loan money has come to Pakistan, forex reserves have increased, and is part of the reason for stability of rupee.

In addition to this, the government is keeping the rupee over-valued. Some experts are of the view that rupee is over-valued by 20 percent. The purpose is to make sure that debt stocks in rupee terms look slimmer for political leverage. An over-valued and stable rupee also equips government to rope in foreign loans. Bilateral and multilateral sources prefer to give credit to a country that maintains a stable currency. Pakistan will not be successful to float Euro bonds and finance its expenditure unless rupee is stable. Therefore, the exchange rate policy choice in Pakistan is marked by politics and Pakistan’s relations with foreign creditors. But how has it impacted Pakistan?

The effects of this policy choice have been two-pronged with both positive and negative bearings. First, Pakistani exports have been on the receiving end resulting in loss of competitiveness. An over-valued rupee renders exports dearer for the world and imports cheaper for Pakistanis. Secondly, input import intensity of Pakistani businesses has increased since 2013. Share of capital goods in total imports of Pakistan was 15 percent in 2013, which jumped to more than 20 percent in 2015. Similarly, imports of machinery and transport have increased by eight percent since 2013.

In a sense, this can improve productivity of our businesses since foreign inputs are more efficient than local ones. But then local suppliers of the same inputs can be phased out of the market. Pakistani cement industry is facing tough competition from Irani cement that is cheaper than ours. If rupee appreciates by one percent, Irani cement will become cheaper by exactly one percent. As Pakistan is now enjoying a construction boom, this may compromise the benefits that Pakistani cement industry can have. Take another example of indigenous coal. For CPEC projects, coal is being imported from South Africa and Indonesia because coal from these countries is cheaper. An over-valued exchange rate will make imported coal look even cheaper hampering usage of indigenous coal from Thar.

These trends can reinforce themselves and turn current account deficit to astronomical levels if Pakistan continuous to follow policy of an over-valued rupee by intervening in the forex market. As demand for dollar rises due to increasing imports, rupee may fall prey to a speculative attack. Pakistan’s ability to defend rupee will depend on forex reserves. Although we now have record high forex reserves, history can tell us how fast they deplete in an event of a speculative attack. No country has managed to artificially maintain the value of its currency without a speculative attack. We can learn from these examples.

In 1997, Thailand’s current account deficit increased by 79 percent as baht was artificially kept stable for many years prior to 1997. That same year the Thailand Baht was forced to lose as much as 20 percent of its value in one day as it fell to speculative attacks. The currencies of other South East Asian countries also nosedived due to similar circumstances. What followed was an economic pain as GDP growth for most of these countries turned negative. The ‘Asian Growth Miracle’ went bust due to a stable exchange rate policy.

What can Pakistan do now? The best solution can be to liberalise forex market and not wait for the time when like Thailand’s Baht rupee is forced to lose value. Let the market decide the true value of rupee. A market driven rupee will keep our current account deficit from increasing to high levels. It may even diminish possibility of a speculative attack due to self-correcting mechanism of liberal markets. We can practically do it now since Pakistan has completed the IMF program. But only if we set aside politics from economics, that is.

The writer is a research associate at the Policy Research institute of Market Economy, an Islamabad-based economic policy think tank