We have seen the consequences time and time again, but no lessons have ever been learned.
With the decline in the value of the Pakistani rupee in recent weeks and now the return of Ishaq Dar as finance minister, discussions around a fixed exchange rate have resurfaced.
Like Reagonomics, or Thatcheronomics, we have our own version: Daronomics, where the obsession with having an overvalued PKR trumps all other economic and social needs, resulting in an accelerated recovery, which gives rise to a fired boom by consumption, followed by a crash when the supply of foreign currency to support the PKR dries up.
During his previous stint as finance czar from 2013 to 2017, Dar used the central bank to pump dollars into the market in a bid to artificially keep the value of the greenback around 90 rupees.
But this approach is problematic because pricing has never worked. On the contrary, the longer the prices remain fixed, the more serious the consequences are later. Whether it is a price floor or a price ceiling, market forces ultimately prevail. We have seen this happen time and time again, but no lesson has ever been learned.
The obsession with pricing PKR, whether against the US dollar or other currencies, has been a top political priority despite the consequences such a strategy could have. The value of a currency depends on the country’s ability to generate enough foreign exchange, whether through exports, remittances, investments or additional borrowing. As the supply of foreign currency increases, its value decreases while the value of the PKR increases.
Pakistani exports do not really have a competitive or comparative advantage, which makes sustained and robust growth in export earnings a distant dream. Pakistanis abroad actually send more remittances than the country as a whole earns from exports. Given the general environment of the country, foreign direct investment has remained extremely low and is not expected to increase any time soon.
The abundance of low-cost or near-free liquidity over the past decade due to near-zero interest rates for the dollar and other major currencies has led to easy availability of credit. As a result, Pakistan profited for almost four years by keeping the PKR-USD peg in a tight range, which at one point was overvalued by almost 25% in real effective exchange rate terms.
A major disadvantage of an overvalued currency is that exports become uncompetitive in the international market, leading to a decline and therefore increasing the overall trade deficit. During the years when the exchange rate was “fixed”, consumption was driven by imports, which in turn were financed by more dollars.
However, in recent weeks, central banks around the world have been rapidly raising interest rates as the US Federal Reserve adopted a hawkish monetary policy. As a result, investors dumped risky assets and turned to the safer dollar, increasing demand for the greenback. The increase in demand then led to a jump in the value of the dollar against various developed and emerging market currencies.
The US dollar index, which measures the value of the dollar against six world currencies, has jumped nearly 15% since the start of this year and the greenback hit a 20-year high. Its move has been so drastic that even the Pound and Euro have fallen to historic lows in recent days.
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In such a macroeconomic environment where the major currencies are falling, the PKR stands no chance when the country’s reserves have fallen to less than 5% of its GDP and more than half of its income is spent on debt service. local and external.
If the leaders want the PKR to appreciate, that would mean they want an overvalued rupee, which would have a debilitating effect on exports. More importantly, it would make imports cheaper, thereby increasing the demand for dollars to satisfy consumer appetite – all at a time when the cost of borrowing dollars has risen dramatically.
In the aftermath of the devastating floods, the country’s fiscal and external position is already strained. The stress is so severe that there has been talk of debt moratoria and the reprofiling of external debt to give the economy some breathing room, so that more resources can be allocated to rehabilitation and reconstruction.
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However, the narrative being thrown around of aiming for a significantly appreciated PKR does not logically work for a country that wants its external debt to be reprofiled. In such a scenario, there is a possibility that any concessions given will simply be wasted on appreciation of the value of the PKR, instead of building back better or making structural changes.
If the same narrative and eventual policy talk kicks in, we could have a few months of import-led, consumption-driven growth. Similar to how a surge of ecstasy travels through the veins of a drug addict only to be followed by a disastrous meltdown, political economic policy would ultimately lead to a scenario where we may once again have to go to the Monetary Fund international and get another bailout after wasting precious foreign currency and concessions while obsessing over an overvalued PKR.
With foreign exchange reserves at dangerously low levels and the conditions of the ongoing IMF program, under which Pakistan accepted a market-based exchange rate regime in addition to a state bank free from heavy-handed tactics of the government, it seems that the hands of the new finance minister are tied. But in his first comments after taking the reins, Dar was outspoken in saying he thinks the rupee is “undervalued”.
For Pakistan, the choice is clear.
We can either reform and restructure the economy and reduce reliance on import-led consumption, or go through another very short growth cycle and collapse again with even more debt than before.