Currency Devaluation in Pakistan

Currency devaluation is formally known as depreciation of local currency against gold or other countries currencies. Currency devaluation is normally measured as a way to muddle through the Balance of Payment. Analysts usually hold up the point of view that currency devaluation could be prolific for the local economy, as devalued currency will intensify the national exports and also causes an increment in the employment level of country, consequential heighten economic growth. Importunate undesirable balance of trade and unevenness in BOPs (Balance Of Payments) forces the national currency to devaluate.

In case of Pakistan, history has stated that devaluation of currency usually comes with high whole sale prices and elevated irrepressible inflationary pressure. It has also been experienced that Pakistan has never enjoyed the increment in the exports as a result of devaluation in Pakistani Rupees. Pakistan had first experienced devaluation in 1952 leading to heightened whole sale prices and uncontainable inflationary pressure. This was also eminent in 1972, when a Pakistani rupee was diminished by 56.7% against united dollar $ rate. Consequently an export voucher scheme at that time was exterminated by this devaluation. One of the highest devaluation in currency has been stated in 1996.

This led to increment in domestic prices as sugar had been internationally traded in US $ in 1996. To rescue the situation 10% import tariffs had been confiscated by the government on imports. The recent profound currency devaluation experience Pakistan has noted is from 2006 to till today. A common perception of increase in employment by the devaluation of currency is normally supported by the argument that it will step up the manufacturing activities within country. Unfortunately this argument grounds have never been usually successful in Pakistani dilemma of currency devaluation. This devaluation will also cause loan repayment quite difficult for large enterprises resulting in lower investing activities hence lower employment opportunities. Further this issue liability could be diversified in to various bullets like political instability, Pak-Indo wars and Terrorism along with some economic aspects.

Its true that Devaluation is used as financing tool to manage the BOPs (Trade Deficit) but limitations come when country Rupee falls very abruptly. This will restrain foreign investors to invest in the country facing this situation, this would also make quite difficult and unfeasible for a country to finance the current account in BOPs. This has been the case with Pakistan since 1952 to 2007-2012 and this point has enlightened why Pakistan has been unable to reap the benefits of currency devaluation?

Another radical reason of inability of extracting possible juice from the currency devaluation is inelastic exports of Pakistan. Traditionally Pakistani markets deal in goods having non-elastic demand in foreign markets, this result in no substantial increment in the level of exports. This is because Pakistan does not deal in value added exports like Japan in Automobile industry, Americans in new technology innovations etc. On the contrary side of developed and developing countries, Pakistan has major exports in raw form. Further to the issue our raw material has never been in a position to compete in foreign markets. Pakistani industry is also again reliant on raw material imports for their industrial goods and capital goods.

During devaluation, quotas and tariffs are imposed as a financing tool on the access of raw material from the advanced countries. This would result in boosted industrial cost and reduction in amount of capacity utilization. There for it should be avoided as a financing tool for trade deficit as it was observed in 1997 when government had eliminated the tariffs by 10% to lower the domestic prices.

So, by examining devaluation in Pakistan it is concluded that it has always led us to the cost push inflation and never ending cruel economic circle. Long term plan is required which will supply us structure for having branded high valued products, ample enhancement in quality and image of current exports and searching better fresh markets with sublime marketing strategies. This would surely enhance our capability to reap the possible benefits from the currency devaluation. Review of Literature on Interaction between Capital and Currency Markets

Depreciation of Pakistan rupee against US dollar since the beginning of 2008 has nearly stopped economic growth in all major spheres of the economy. The rupee has touched record low of 94.80 against the greenback in interbank market and 95.40 in kerb market. The widening current account deficit, excessive government borrowing from State Bank, absence of foreign flows increasing oil imports, lack of foreign investment and repayments to the International Monetary Fund are the vital reasons for constant depreciation of Pak rupee. Worsening economic condition in the country deteriorating law and order situation, energy crisis and terrorism are the main causes of sinking rupee which witnessed sharp devaluation during a couple of years. Various macro economic sectors which are predominantly relying on imports have experienced an increase in their cost of production. Depreciation of the rupee is intensifying the cost of doing business and badly affecting the industrial and manufacturing sectors as Pakistan has to import fertilizers, food items, oil, machinery and industrial raw material. The depreciation of the currency is not always favorable for the economy, as it is one of many ways to push up the economy's export. For a short term the depreciation of currency may be better for the country but in the long term this does not only result in loss of exports, but for the entire economy as a whole. Pakistan was expecting to contribute to its deficit financing the Coalition Support Fund, US aid, 3G auction and Etisalat payments but this was not materialized. This exerted pressure on financial account and rupee started weakening against US dollar. Pakistan is also paying back to the IMF with three tranches of $1.2 billion and other debt obligations around $1.7 billion made by the government. The outflow of dollars, debt servicing, has exhausted liquid reserves. Constant adverse trade balance and disequilibrium in balance of payment compels Pakistan to depreciate its currency. Adverse trade balance is generally the result of slackness in exports in comparison to imports. The markets for Pakistan's traditional export are inelastic, therefore depreciation of currency may in fact give no big encouragement to its exports, because there is a small quantity of value added exports and major requirement is based on export of raw material. Furthermore, the quality of export not competitive in the international market. Pakistani rupee is losing fast against regional currencies as it remained just half against the Indian Rupee and the Bangladeshi Taka also appears much stronger than the Pakistani currency. To get 100 Indian rupees, we have to pay Rs185 to

Rs190. One hundred and twenty-five Pakistani rupees are required to get 100 Bangladeshi Takkas. Bangladesh received some good achievements in textile exports but it is not a large economy with good resources. India showed strength in its economy during a year when the global economy was in critical situation because of economic and financial crisis in the United States and Europe which finally absorbed the entire world. On the other hand in this hour of financial meltdown Pakistani currency depreciation was more domestic than global phenomenon. Its high inflation and poor economic performances shattered confidence on local currency. Pakistan's foreign exchange reserves are in precarious condition. It is likely that the rupee may reach Rs 100 mark against Unites States Dollar if balance of payment situation is not corrected. In the midst of escalating oil import bill as well as repayment of $2.6 billion to the IMF the local currency situation will be further worsened in the forthcoming financial year 2013. However, uninterrupted increase in remittances may solve the problem of repayments easily and stabilizing the exchange rate. If such a trend of record fall of Pakistan's rupee goes on non stop than the nation may seek loans from the International Monetary Fund to pay debts. The price of imports are anticipated to further increase which will only put maximum burden on the entire economy and the export industry, as the cost of production for the export goods in directly related to the imported good. Government should take immediate measures to control further devaluation of rupee to avoid more damaging consequences for the economy. Further fall in value of rupee will cause more dwindling in economic activity leading to reduced tax revenue for government and huge foreign debt. In this context the government should speedily halt this grave trend to bring stabilization in exchange rate to protect national economy from further impairment. Depreciation of the rupee at its current stride won't step up exports, rather will certainly expand import bill and inflation. It will also lower the competitiveness of Pakistan's business and industry. A long term ambitious plan is required to put the economy on the right track. This should provide a model for exporting value added branded products, bettering the quality and image of existing products, finding new export markets and better aggressive marketing strategy. We should try to adequately utilize the human resources, which is sufficient in Pakistan and is not fully exploited. Furthermore, cut in unnecessary government expenditure, improvement in budget and trade deficit, multiple and persistent

exchange rate would also be of great assistance. Merely depreciation of currency is not the solution of the current economic crisis and should not be resorted to in near future. Every section of economy is interconnected, like currency is attached with economic performance. Pakistani rupee may fall further if economy does not improve and war like situation in North of Pakistan is not stopped. Exports are not in good condition since the cost of doing business has gone up in Pakistan and highest in the region which means less chance for lowering of trade imbalance. This big size depreciation would ultimately hit the exports as the imported raw materials would be costlier. The State Bank and other stakeholders much check this situation which could be catastrophic for the entire economy. currency crises. During the month of May08 Pakistan Inter-bank and Kerb forex markets witnessed a sharp decline in Pak Rupee value versus US$. Despite the Central Banks intervention and some regulatory steps, Pak Rupee continuously losing its value. Under a floating FX rate system, the exchange rate decline is expected & a necessary component of the adjustment mechanism. There are so many factors that cause currency crises to occur, i.e. economic, political, corruption, etc., but to determine the route causes of current crises, let us focus only on the major economic variables, these variables are interlinked with each other, therefore, it cant be sure that which one triggers the other: a) Price shocks (Includes decline in Export commodities prices or inclined in Import commodities prices) One of the major and most discussed cause of current crises is the ever-rising price of imported crude oil, which hit close to a record $127 a barrel on May 15 and an all-time high of $128 a barrel the next day amid widespread fears over stretched global energy supplies. b) Expansionary fiscal or monetary policies adopted by the previous government in order to stimulate the economy, and which cause aggregate demand to grow at a pace higher than domestic supply. The gap between aggregate demand and domestic supply is filled by imports. The result is that imports grow more quickly than exports. Current account deficit goes up, which has to be financed through either falling foreign exchange reserves or capital inflows. Capital inflows, however, may not be forthcoming because of lack of trust in the countrys financial situation.

c) Fiscal deficit, previous Government resorts to borrowing from the central bank or from foreigners to meet huge PSDP expenditures. Borrowing from the central bank increased the inflation. High inflation is proved lethal for export, because it distorts prices. In particular, inflation increases the input cost of exportable goods and makes them less price competitive. As far as foreign liabilities are concerned, Pakistan total external liabilities surged to $45.822 billion by the end of March 2008, compared to $42.882 billion on December 31, 2007. Although former Prime Minister Shaukat Aziz and his team of ministers claimed that their government had broken the begging bowl, figures of the State Bank of Pakistan (SBP) showed a different picture. Five years ago on June 30, 2003, total external liabilities of the country stood at $35.439 billion. The break-up of figures shows that public and publicly-guaranteed debt increased to $40.479 billion by March 31, 2008, which was $37.836 billion on December 31, 2007 d) Weaknesses of domestic financial system also contribute to the eruption of a crisis. Foreign capital plays an important role in economic development. However, in many cases capital inflows have been volatile. Increased capital flows have been followed abruptly by equally massive capital outflows. Countries with weak and untransparent financial system are particularly vulnerable to this problem, as happened in case of the Pakistan. The massive foreign home remittance inflow after 9/11, abruptly over stimulate the Equity, Real Estate and essential/luxury commodities markets, in fact our financial system and economic managers has failed to utilize massive inflows into capital and capacity building spending. e) Capital flight, low Foreign Direct and Portfolio Investments are another major contributors of current crises, it is also clearly witnessed by KSE tumble. Foreign investors preferred pulling their liquidity out of the market due to the prevailing political and economic landscape. This capital outflow will result a fall in SCRA (Special Convertible Rupee Account). Foreign Direct Investment in Pakistan during July-April 2007-08 dipped by 16.7 per cent year-on-year to $3.48 billion and portfolio investment by 93.3 per cent to $119.4 million as compared to the corresponding period of the previous fiscal year f) Speculative Pressure, in emerging markets like Pakistan speculation always remains the major factor behind an exceptional behavior. In current crises the speculative factor was further aggravated by the lack of availability of US$ at local Kerb market. Some banks on the other hand engaged in excessive trading

activities, that create undue panic, and they also encourage their export clients to delay the realization of their remittances. According to the State Bank of Pakistan, the countrys total liquid foreign reserves further declined by $48.7 million during the first 10 days of May, 2008, to $12.207 billion on May 10. Thus, foreign exchange reserves have now declined by $4.293 billion from $16.50 billion less than a year ago. g) The Real Exchange Rate: Real FX rate = The relative price of two identical baskets of goods in the two countries. Increase in the real exchange rate creates currency devaluation pressures, because it hurts all firms that are exposed to foreign competition. Exporters suffer, because their costs are higher when measured in terms of foreign currency. Firms facing import competition are hurt, because foreign producers are under no pressure to increase prices with domestic inflation. The impact of an increase in the Real Exchange Rate depends to a great degree on the Trade to GDP ratio, an appreciation of the Real Exchange Rate of a country with a high Trade to GDP ratio is particularly worrisome because exports are not competitive in world markets, and imports capture a greater market share in the domestic market.