KEEP the dollar flying (i.e. keep it relatively expensive). Why? Why not make the rupee fly (i.e. keep it relatively overvalued)? There are very simple reasons to prefer the first approach to the second to keep our economy flying, rather than having a forced landing. To understand the reasons, imagine that you are a businessman with two choices. The first choice is to start an import business. The second is the export activity. Which one will you choose in our country? Import or export? Many will (and still choose) the import business because it requires little investment and is much easier to set up. Very few will choose the export activity because it requires huge investments and is difficult to set up. Is it too difficult to see this reality on the ground? This is one of the main reasons for keeping the exchange rate more favorable for exporters. Keeping it consistently more favorable for exporters also helps producers, thus promoting industrial growth.
For decades – and from July 1949, barely eight months after the death of the Quaid – our policymakers deliberately chose to keep the rupee overvalued by not devaluing it despite the UK devaluing the pound sterling by 30 %. All the countries of the Commonwealth have done it except ours. The pound sterling became cheaper in Pakistan, and dependence on imports began under the guise of the then fashionable “import substitution strategy”. Since then, our country has been on a trajectory of faster import growth, slower or stagnant export growth, growing external debt needed to finance the import-export gap, and hence boom cycles. and slower growth.
The fear of exchange rate flexibility was shared by most, if not all, of our finance ministers.
Our exchange rate has historically favored importers over exporters. Yet we continue to bemoan our poor export performance. We seem to prefer the easier approach of whining rather than making the difficult decision to keep currencies always expensive. Should we also congratulate ourselves on our extraordinary performance in import growth? Our politicians, policymakers, bureaucrats and many economists (of national or media repute) continue to delude themselves that the expensive dollar is mainly the work of speculators, and must be stabilized (a euphemism to prevent the dollar from flying, or to keep it almost fixed).
Many economists continue to make strange arguments such as “depreciation leads to increased debt”. They fail to see that by not depreciating in time, we primarily fueled import consumption, which was mainly financed by the increase in external debt. Many still believe that exports do not react to the exchange rate, based on silly econometric regressions. The point is that exports react slowly to depreciation relative to imports for the reasons stated in the first paragraph. Many continue to say that the import content of our exports is very high, but never ask why it is high. It is high mainly due to the historically favorable exchange rate for imports i.e. the overvalued rupee.
Pakistan established a “managed float regime” in 1982. As a result, our trade balance improved between 1982 and 1998. If the rupee had shown more flexibility in the exchange rate during this period, our country would have developed a strong and diversified export base. In addition, one might have expected a better performance of the trade balance when the pak rupee was officially “floated” in 2001. But soon after, the fear of floating fiercely took hold in the minds of people. makers and the rupee has barely gone from around Rs 60 to a dollar. (2001-2007), making it a “de facto anchor” – putting the economy back into the fixed exchange rate regime of before 1982.
This fear of floating, benefiting importers at the expense of exporters, wreaked havoc on the trade deficit, and the economy collapsed under the onslaught of the 2007-08 global financial crisis. Foreign exchange reserves quickly disappeared. The IMF helped stabilize the economy and the rupee became somewhat flexible again from 2008 to 2013. Fear of floating re-set in and the dollar was deliberately kept cheaper between Rs98 and Rs104. History repeated itself. The trade deficit increased and reserves were depleted. What was mind-boggling was how the “savings” resulting from the dramatic drop in the international price of oil (from $ 100 per barrel in 2012 to $ 40 in 2016) were wasted to support the rupee and increase imports. . No wonder exports declined or stagnated over the period 2013-2018.
The IMF again helped. The rupee has shown flexibility and the economy has stabilized. The State Bank introduced a sensible mechanism of “market determined exchange”. Now, since October 2, 2021, the fear of floating seems to have set in again. This fear is evident in the remarks by Finance Minister Shaukat Tarin that the dollar should cost no more than Rs 165, instead of the current market value of almost Rs 172. This fear and disregard for flexibility is not new and had been shared by most (if not all) of our former finance ministers. Unfortunately, this fear is also reflected in the words of various economists of national renown.
As a result, the State Bank will undoubtedly be pressured to intervene. If this happens, it will lead to the depletion of reserves leading to another balance of payments crisis. I hope that will not happen. I want the State Bank to be allowed to do its job independently. Our Prime Minister is a brave man. He asked all Pakistanis not to be afraid of so many things. May I now respectfully implore him not to be afraid of the rising dollar? Trust the State Bank of Pakistan to handle the exchange rate independently. Very few public sector institutions can boast a competent staff and an experienced and knowledgeable board of directors like the State Bank. Let the rupee float. It takes enormous and continued patience to reduce dependence on imports, promote exports, increase reserves and contain external debt. If the wishes were horses, surely our country would be an Asian tiger now. If the wishes of finance ministers become the horses of the State Bank, our country is unlikely to emerge from cycles of booming and slowing economic growth.
The writer is a former deputy governor of the State Bank of Pakistan.
Posted in Dawn, October 9, 2021