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Friday March 29, 2024

Depreciating the rupee

By Editorial Board
December 11, 2017

There has been an ongoing debate about whether the Pakistani rupee would remain stable against the US dollar. The World Bank and IMF have advised Pakistan to depreciate its currency to improve its balance of trade – but Pakistan’s financial managers have continued to reject the logic. Last Thursday, the Pakistani rupee began depreciating suddenly against the US dollar and ended at around four percent less on the same day. After reaching a high of just over Rs110 to a US dollar, it stabilised around Rs106.5 to a US dollar. The burning question was: is this a chance event or a policy decision? Given how much resistance the government had put up to the IMF and other international agencies, at the time it seemed unlikely to be a government decision. However, it has turned out that it was indeed a policy decision taken during a meeting between the IMF and the finance ministry. The government seems to have succumbed to IMF dictates once again rather than taking an independent decision. This is what perhaps explains why the UN Economic and Social Commission for Asia and the Pacific issued a warning to Pakistan last week that it would be difficult for the government to keep its exchange rate stable in the current environment. But it is still a strange decision – especially since it appears to have been deliberately timed to be taken after Pakistan’s decision to raise $2.5 billion through bonds.

The logic for issuing the bonds first and then devaluing the currency does not seem obvious, since the bond issue is in US dollars. However, the new bond issue could work to improve the government’s position to be able to stabilise the Pakistani currency at a point of its choosing. The decision to devalue the currency could have benefits but also has significant risks. Currency devaluation is a strategy designed to suit net exporters, not net importers. Pakistan is in the position of having its trade deficit spiral out of control. There is no logical reason why the decision to depreciate the currency would lead to an increase in exports. Instead, it could end up increasing the cost of production for some export-oriented industries through the indirect effect on wages, import costs and oil prices. All is not well with the Pakistani economy just yet. Both economic growth and inflation in Pakistan are set to rise, but the biggest issue remains the ballooning current account deficit. There are no easy solutions to arresting this decline. This is why it is even more difficult for the Pakistan government to predict where the currency might stabilise. And once you open the door to currency speculation, the ability to predict where it will land is much harder. It will be important to watch the changes in the value of the rupee closely this week.