Pakistani rupee made a relatively stable start against the dollar during the first session of the year, closing at around 227 on January 3, 2023. However, the parallel market rates for the greenback have exceeded the Rs250 mark as dollar supply tightens and the country approaches a $1B loan repayment due next week.
Exchange Companies Association of Pakistan have also stepped up by providing assurances to the Finance Minister Ishaq Dar of convincing the Pakistani diaspora to send in remittances through official channels. The efficacy of this measure, however, would be limited as a few million dollars are not a solution to the problem at hand.
Rather, what seems a likely solution is to set the exchange rate free and let the markets decide its rate considering that the State Bank of Pakistan has already revoked import restrictions -- thus intervening in the currency market becomes more expensive for the country.
As per a policy brief paper issued by Sustainable Development Policy Institute (SDPI), “Since its inception, Pakistan has been through different exchange rate management policies. Initially, Pakistan pegged its rupee to pound sterling with the rate of pound sterling 1 equal to PKR 11.43. This peg lasted till 1972. Thereafter, PKR was pegged to US dollar wherein US$ 1 was equal to PKR 9.90. Pakistan adopted a managed floating rate in 1982 which ended in 1998. Since then, the country has announced policy of following a flexible exchange rate regime.
“Developing countries, particularly, misalign the currency toward upper side and prefer overvaluation. An overvaluation of currency may initially sound good as it increases the purchasing power. This may generate some political gains in short run as the government may claim improved purchasing power of people an outcome of its successful economic policy. It is important to note that overvalued currency along with other implications makes the exports of the country expensive. Some other country may supply the same products at cheaper rate resulting in loss of exports for the economy with overvalued currency. Further, a strong currency may also increase imports creating current account deficit,” read the policy paper.
Therefore, a market-based exchange rate promotes efficiency in the economy and amongst other things, helps in commodity pricing decisions which provides some cushion against external shocks.
More importantly, a market-based exchange rate is also a condition laid by the IMF for releasing the pending loan tranche. The fund is well within its rights to ask for this adjustment as Pakistani governments have a history of exhausting funds to keep the rupee appreciated rather than making structural reforms.
As per a report by Ismail Iqbal Securities, “During the year (2022) PKR has lost 22% against USD, which can mostly be linked to higher inflation in Pakistan, as REER has remained flat. Unlike previous bust cycles, Pakistan has not maintained a fixed peg against USD, and has maintained REER below 100. However, precarious reserves position and thriving black market has created a big gap of over 10% between interbank and informal market. To address this, govt is likely to let REER depreciate to encourage exports and remittances, disincentivize imports and use of alternate channels. We expect USD/PKR to reach 250 by FY23 end.”
However, letting the rupee slide would have its own implications, one being a spike in inflation which is already at a record high.
“Consumer prices rose 24.50% in December from a year earlier, according to data released by statistics department Monday. That compares with a median estimate for a 24% gain in a Bloomberg survey and a 23.84% jump in November. Food inflation quickened 35.5% year-on-year, while transport prices rose 41.2%, data showed. Clothing and footwear prices accelerated 17.1% and housing, water and electricity costs rose at 7%,” read a Bloomberg article.
However, experts are of the view that the country is stifled for alternatives. “Letting the market mechanism prevail is the need of the hour, but the fallout from it would further propel inflation as fuel and food prices will go up. An effective way to deal with it is by providing handouts through frameworks like BISP rather than controlling the exchange rate and providing a blanket relief,” says economist Fahd Ali.
Dr. Farrukh Saleem, a senior journalist and analyst said, “The government has no alternative left except for negotiating with the IMF. A prerequisite for it is to let the market forces decide the exchange rate. The reluctance on the governments side is due to the immediate impact of the decision which could see the food inflation rise by 10-15 percent on the back of a devalued rupee.”
Though the country finds itself in a fix, this maybe the perfect opportunity to change its course and take some long-term decisions rather than relying on patchwork.
“The remedy to our dollar problem lies in propping up the FDI inflows as a current account deficit is a constant feature of developing economies. In the long run, investments can only be increased by improving the ease of doing business and establishing the respect of contract in this country. However, to deal with the immediate crisis, the government would need to mobilize investments from overseas Pakistanis through targeted projects,” said Idrees Khawaja, economist at PIDE.
Exchange Companies Association of Pakistan have also stepped up by providing assurances to the Finance Minister Ishaq Dar of convincing the Pakistani diaspora to send in remittances through official channels. The efficacy of this measure, however, would be limited as a few million dollars are not a solution to the problem at hand.
Rather, what seems a likely solution is to set the exchange rate free and let the markets decide its rate considering that the State Bank of Pakistan has already revoked import restrictions -- thus intervening in the currency market becomes more expensive for the country.
As per a policy brief paper issued by Sustainable Development Policy Institute (SDPI), “Since its inception, Pakistan has been through different exchange rate management policies. Initially, Pakistan pegged its rupee to pound sterling with the rate of pound sterling 1 equal to PKR 11.43. This peg lasted till 1972. Thereafter, PKR was pegged to US dollar wherein US$ 1 was equal to PKR 9.90. Pakistan adopted a managed floating rate in 1982 which ended in 1998. Since then, the country has announced policy of following a flexible exchange rate regime.
“Developing countries, particularly, misalign the currency toward upper side and prefer overvaluation. An overvaluation of currency may initially sound good as it increases the purchasing power. This may generate some political gains in short run as the government may claim improved purchasing power of people an outcome of its successful economic policy. It is important to note that overvalued currency along with other implications makes the exports of the country expensive. Some other country may supply the same products at cheaper rate resulting in loss of exports for the economy with overvalued currency. Further, a strong currency may also increase imports creating current account deficit,” read the policy paper.
“Letting the market mechanism prevail is the need of the hour, but the fallout from it would further propel inflation as fuel and food prices will go up. An effective way to deal with it is by providing handouts through frameworks like BISP rather than controlling the exchange rate and providing a blanket relief,” says Fahd Ali.
Therefore, a market-based exchange rate promotes efficiency in the economy and amongst other things, helps in commodity pricing decisions which provides some cushion against external shocks.
More importantly, a market-based exchange rate is also a condition laid by the IMF for releasing the pending loan tranche. The fund is well within its rights to ask for this adjustment as Pakistani governments have a history of exhausting funds to keep the rupee appreciated rather than making structural reforms.
As per a report by Ismail Iqbal Securities, “During the year (2022) PKR has lost 22% against USD, which can mostly be linked to higher inflation in Pakistan, as REER has remained flat. Unlike previous bust cycles, Pakistan has not maintained a fixed peg against USD, and has maintained REER below 100. However, precarious reserves position and thriving black market has created a big gap of over 10% between interbank and informal market. To address this, govt is likely to let REER depreciate to encourage exports and remittances, disincentivize imports and use of alternate channels. We expect USD/PKR to reach 250 by FY23 end.”
However, letting the rupee slide would have its own implications, one being a spike in inflation which is already at a record high.
“Consumer prices rose 24.50% in December from a year earlier, according to data released by statistics department Monday. That compares with a median estimate for a 24% gain in a Bloomberg survey and a 23.84% jump in November. Food inflation quickened 35.5% year-on-year, while transport prices rose 41.2%, data showed. Clothing and footwear prices accelerated 17.1% and housing, water and electricity costs rose at 7%,” read a Bloomberg article.
However, experts are of the view that the country is stifled for alternatives. “Letting the market mechanism prevail is the need of the hour, but the fallout from it would further propel inflation as fuel and food prices will go up. An effective way to deal with it is by providing handouts through frameworks like BISP rather than controlling the exchange rate and providing a blanket relief,” says economist Fahd Ali.
Dr. Farrukh Saleem, a senior journalist and analyst said, “The government has no alternative left except for negotiating with the IMF. A prerequisite for it is to let the market forces decide the exchange rate. The reluctance on the governments side is due to the immediate impact of the decision which could see the food inflation rise by 10-15 percent on the back of a devalued rupee.”
Though the country finds itself in a fix, this maybe the perfect opportunity to change its course and take some long-term decisions rather than relying on patchwork.
“The remedy to our dollar problem lies in propping up the FDI inflows as a current account deficit is a constant feature of developing economies. In the long run, investments can only be increased by improving the ease of doing business and establishing the respect of contract in this country. However, to deal with the immediate crisis, the government would need to mobilize investments from overseas Pakistanis through targeted projects,” said Idrees Khawaja, economist at PIDE.