Daily Times

The current downhill ride of the rupee is more striking than before. It will make the grounds for high inflation in the future. The general public’s perception of inflation is that the exchange rate is a major driver of inflation in an economy.

While the recent brief of well-known Pakistani economist, Dr Abdul Jalil Khan, published by the Pakistan Institute of Development Economics (PIDE) unveiled that in developing economies (like Pakistan), the contribution of the exchange rate to inflation is only 20 per cent. Other factors like monetary policy, external shocks, internal demand, and supply contribute around 80 per cent to the inflation in developing economies. The contribution of the exchange rate in inflation is sliding down over time.

According to estimates, one per cent of exchange rate depreciation brings an increase of around 14-16 basis points in the general inflation level of Pakistan if other things remain constant. But if other factors are allowed to be variable and proper monetary policy for demand management is in place, a positive supply-side shock may further soften the effect of the exchange rate on inflation.

People of Pakistan consider foreign debt a major economic problem of Pakistan, even though it is not a big economic problem of Pakistan. The current level of foreign debt of Pakistan is $122.1 billion, which is 40.3 percent of GDP as of 2021. It is lower than the threshold level of 65 percent because according to a study by World Bank, an additional percentage point of debt over 64 percent, annually slows growth by 0.02 percentage points.

Exchange rate depreciation and foreign debt are not major economic problems of Pakistan when examined in isolation.

The current level of foreign debt of Pakistan is lower than other countries like the United States, the United Kingdom, Greece, Cyprus, Singapore, Japan, and others that have foreign debt more than the GDP. The foreign debt of Pakistan is not curbing the economic growth of Pakistan because: 1) it is less than the threshold level; 2) most of the countries are growing economically even they have higher foreign debt when compared with Pakistan.

In a broader context, exchange rate depreciation and foreign debt are not major economic problems of Pakistan when examined in isolation. But foreign debt and exchange rate are a complement to curb the economic growth of Pakistan. The unstable exchange rate made foreign debt a major economic problem in Pakistan. For instance, in 2016 the foreign debt of Pakistan was $73 billion, and at that time the exchange rate was 102 a dollar. Let’s assume that if the foreign debt remains the same in 2021 and we consider the current exchange rate 170 a dollar. It means that foreign debt surges from 7501 billion to 12424 billion rupees. It is adding 4923 billion rupees to foreign debt, which is almost 60 percent of the budget for 2022, and more than the tax collection amount of the fiscal year 2021, which was 4725 billion rupees.

This surge of foreign debt in a local currency not only curtails short-run economic growth but also decelerates the development of Pakistan. Because there is a trade-off between debt servicing and human capital development due to the surge in foreign debt. If this amount is utilised for the citizens of Pakistan, it may provide better education, health, infrastructure, and avenues for research and development, which, in turn, would drive the long-run economic growth of Pakistan.

The stability of the exchange rate is important because a developed country like Singapore with a foreign debt of more than 400 percent of GDP is maintaining the exchange rate in the range of 1.31SGD/USD to 1.45SDG/USD over the last five years. Its current exchange rate is the same as that five years ago. Similarly, the foreign debt of Japan is also more than 200 percent of the GDP and it is also maintaining its exchange rate in the range of 101JPY/USD to 117JPY/USD over the last five years. Contrarily, the exchange rate of Pakistan depicts grave instability over the last five years as it has depreciated almost 70 percent and plummeted from 102 in July 2016 to 171 to a dollar in October 2021.

The stability of the exchange rate depends on the exchange rate management. The managed floating exchange rate may ensure stability but consequently lower the foreign exchange reserves of Pakistan. While market-based flexible exchange rate may not turn up stability unless exports and imports of goods and services did not align. Currently, imports outstrip exports and the value of imports of Pakistan is two-fold exports, which are witnessed by the higher trade deficit. A reduction in the trade deficit over time is required because remittances are not sufficient to feed the widening gap of the trade deficit. There is needed a raft of policy measures to slice the trade deficit and achieve exchange rate stability to accelerate the long-run economic growth.

The writer is a lecturer at Minhaj University, Lahore. He can be reached at waqas.eco@mul.edu.pk.