We have seen the consequences time and again, but no lessons have ever been learned.
With the decline in the Pakistani rupee’s value in recent weeks and now Ishaq Dar’s return as finance minister, discussions around a fixed exchange rate have emerged once again.
Like Reagonomics, or Thatcheronomics, we have our own version: Daronomics, where the obsession to have an overvalued PKR outweighs all other economic and social needs resulting in an accelerated stimulus, which gives birth to a consumption-led boom, followed by a crash when supply of the foreign currency to prop up the PKR dries up.
In his previous stint as the finance czar from 2013 to 2017, Dar used the central bank to pump dollars into the market with the aim to keep the greenback’s value artificially around Rs90.
But this approach is problematic because fixing prices has never worked. On the contrary, the longer prices remain fixed, the worse the consequences are later. Whether it is a price floor, or a price ceiling, market forces eventually prevail. We have seen it happen time and again, but no lessons have ever been learned.
The obsession with fixing the PKR’s price, whether against the US dollar or other currencies, has been a top political priority despite the consequences such a strategy might have. A currency’s value is driven by the country’s ability to generate adequate foreign exchange, whether through exports, remittances, investments, or more borrowing. As the foreign currency’s supply goes up, its value declines while the PKR’s value rises.
Pakistan’s exports do not really have a competitive or comparative advantage which makes sustainable and robust growth in export proceeds a distant dream. Overseas Pakistanis effectively send more in remittances than what the entire country earns through exports. Given the country’s overall environment, foreign direct investment has remained embarrassingly low and is not likely to increase anytime soon.
The bonanza of low-cost to almost free cash during the last decade due to close-to-zero interest rates for the dollar and other major currencies led to easy availability of credit. As a result, Pakistan capitalised on it for almost four years by maintaining PKR-USD parity in a close range, which at one time was almost 25 per cent overvalued in terms of the Real Effective Exchange Rate.
One major disadvantage of an overvalued currency is that exports become uncompetitive in the international market, which leads to a drop and consequently increases the overall trade deficit. During the years that the exchange rate was ‘fixed’, consumption was driven by imports, which in turn, were financed by more dollars.
However, over the last few weeks, central banks around the world have rapidly hiked interest rates as the US Federal Reserve adopted a hawkish monetary policy. As a result, investors have ditched risky assets and gravitated towards the safer dollar, thus increasing demand for the greenback. The rise in demand then led to a jump in the dollar’s value against various developed and emerging market currencies.
The US dollar index, which measures the dollar’s value relative to six global currencies, has surged by almost 15pc since the beginning of this year and the greenback has risen to a 20-year high. Its movement has been so drastic that even the pound and the euro have slumped to all-time lows in recent days.
In such a macro environment where major currencies are tumbling, the PKR does not stand a chance when the country’s reserves are down to less than 5pc of its GDP and more than half of its revenue is spent to service local and external debt.
If those at the helm want the PKR to appreciate, it would mean they want an overvalued rupee, which would have a debilitating effect on exports. More importantly, it would make imports cheaper, thereby escalating demand for dollars to satiate the appetite for consumption — all during a time when the cost of borrowing in dollars has substantially increased.
In the aftermath of the devastating floods, the country’s fiscal and external position is already strained. The stress is so severe that there have been talks of debt moratoriums and reprofiling of external debt to provide some breathing space to the economy, so more resources can be allocated for rehabilitation and reconstruction.
However, the narrative that is being spun of aiming for a considerably appreciated PKR does not logically work for a country that wants its external debt reprofiled. In such a scenario, there exists a possibility that any concessions given will simply be wasted on appreciating the value of the PKR, instead of building back better or making structural changes.
If the same narrative and eventual policy discourse come into effect, we may have a few months of import-driven and consumption-oriented growth. Similar to how a spurt of ecstasy travels through an addict’s vein only to be followed by a disastrous collapse, a politically driven economic policy would eventually lead to a scenario where we may have to go to the International Monetary Fund yet again and get another bailout after having wasted precious foreign currency and concessions all the while obsessing over an overvalued PKR.
With foreign reserves standing at dangerously low levels coupled with the conditions of the ongoing IMF programme, under which Pakistan has agreed to a market-based currency exchange regime in addition to a State Bank free from the government’s strong-arm tactics, it appears that the incoming finance minister’s hands are tied. But in his first comments after taking over the helm, Dar has minced no words in conveying that he believes the rupee is “undervalued”.
For Pakistan, the choice is clear.
We can either reform and restructure the economy and reduce dependence on import-driven consumption, or we can go through another very short growth cycle and collapse yet again with even more debt than before.