Lack of appreciation

The finance minister has a bad reaction to the rupee's natural adjustment

Lack of appreciation
Pakistan’s exports have been stagnating for the last two years, hovering at about $20 billion, compared to $24 billion four years ago. This drop has been precipitated by the fall in commodity prices in international markets, and brings into stark relief Pakistan’s dependence on commodity exports in this age of specialization and high value manufacturing. That, of course, is the larger issue. In the shorter run though, policymakers have been understandably flummoxed about how to deal with this untenable scenario. One obvious textbook prescription is to devalue—a move that is supposed to immediately boost exports by making your products cheaper and thus more attractive to potential buyers.

Whether devaluation actually leads to a significant boost in exports is a moot point in general, and in case of Pakistan also, the matter has been much debated. There are those who contend that such a measure does indeed provide immediate relief, while others assert that devaluation distracts from the real issue: high costs of production which translate into higher international prices for our products. It’s difficult to make a definitive statement without doing some sophisticated data analysis, but the evidence from Pakistan seems mixed. In general, devaluation may have led to short term gains in the past.

One thing that is clear is that in the modern age, maintaining the value of your currency should not be a matter of national pride. Currency ebbs and flows are part of the game. And while sudden devaluations may indeed cause a shock to the system and may be undesirable for countries holding significant foreign denominated debt, it should also be obvious that maintaining an overvalued currency over a long period of time is not wise. Historically, the rupee has depreciated at about 5% a year, but it had been stable since December 2013 in an environment where competitors such as India, Bangladesh and Sri Lanka have adjusted real exchange rates by 15% on average.  All indications are that the rupee is indeed overvalued at present.
Historically, the rupee has depreciated at about 5% a year, but it had been stable since December 2013 in an environment where competitors such as India, Bangladesh and Sri Lanka have adjusted real exchange rates by 15% on average

It was against this backdrop that the devaluation or more accurately, adjustment in the managed float of the rupee took place on July 5. The way it happened was also interesting. The official exchange rate is notified by the State Bank through Foreign Exchange circulars. Another forum for determination of the exchange rate, which in theory at least is deregulated, is the inter-bank market for foreign exchange in which banks carry out currency trading operations. In Pakistan, the State Bank typically intercedes in the inter-bank market to adjust the rate if it falls below a certain level.  In this case, it simply held off and let the market work untrammelled, the way it typically does in developed countries. As a consequence, the rupee began to trade at Rs108.25 to a dollar, compared to Rs105. Trading continued unabated in the morning. By afternoon, the State Bank had acknowledged that it had allowed the rupee to slide.

The central bank is perfectly within its rights to regulate the exchange rate in a managed float situation. It is also perfectly within its rights to allow commercial banks to operate within specified limits and it can make independent decisions on when it needs to intercede in their operations. This is in no way the domain of the Finance Ministry. Yet the reaction from the finance minister was swift, undiplomatic, and frankly bizarre.

First of all, the gentleman started off by saying that no one has the right to interfere in currency markets. Too right. Then he promptly went back on his own word and began to berate market players for allowing the rupee to lose value. What happened in effect, Mr. Ishaq Dar, was that for those few hours that the market was allowed to operate without intercession, it began to move towards setting a more realistic rate for the rupee. And that’s exactly what a market is supposed to do. We do understand that in a managed float, the central bank (and no other actor) retains the right to intervene. In this case, the central bank chose not to do so. Coming down hard on commercial banks and the State Bank for doing their jobs was simply out of line.

The finance minister’s consideration is quite distinct from that of the State Bank and represents the typical tensions between the executive and a political government.  The minister was thinking like a politician who is looking at facing the electorate in another ten months and doesn’t want to admit to the fact that he let the currency drop. The State Bank are essentially bureaucrats less worried about public opinion and more concerned with balancing the books. One can understand where both sides were coming from. But in this case, it was clearly the Bank’s call, and the finance minister was treading on toes. The fact that he acted to appoint a new governor within days and then proceeded to ensure that the rupee appreciated again does not bode well for independence of the central bank. Whatever it is that the government wanted to achieve, it has not come out looking good.

The writer is an independent researcher based in Islamabad