111 510 510 libonline@riphah.edu.pk Contact

Exchange rate volatility and exports

The exchange rate is a crucial component of trade and a dynamic macroeconomic determinant. The trade balance is impacted by exchange rate fluctuations. The growth process is slowed down as a result of unstable exchange rates since they have an impact on capital flows, slow down commerce, and undermine investor confidence. The evaluation of investment operations, hedging, and financing, as well as the reduction of operational risks, are all aided by a stable exchange rate for financial institutions and businesses.

The evolving economic dynamics have changed the world economy and caused numerous difficulties in recent years. This includes rising food prices, inflation, and oil prices. Like many developing countries, Pakistan has also faced backlash because of the international changes as well as national developments such as political instability. Galati and Ho (2003) assert that changes in the news have a significant impact on currency rates. They investigated the idea that any good or positive news raises the value of a currency, but bad news causes it to decline. This has been recently witnessed in terms of the ever developing political instability in Pakistan.

The exchange rate has a two-way relationship with the exports and imports inter alia. The relationship works both ways whereby the fluctuating rate affects the exports and imports, similarly the fluctuating imports and exports affect the exchange rate. In addition to exports and imports, there are other macroeconomic factors that influence the exchange rate. These include interest rates, the current account balance, and the national debt.

The central bank controls the interest rates in an attempt to manage the exchange rates. Foreign investors prefer investing in countries with high interest rates because they can earn greater returns than in other nations. If the interest rate is higher, foreign capital will be drawn in, which will raise the exchange rate. If a country’s current account is in the red, foreign capital is borrowed to close the gap. Local currency loses value due to excessive foreign currency demand.

Moreover, the interest rate in Pakistan was increased by 125 basis points to 15% in July 2022 – following a 13-year peak in inflation, the rate was raised from 13.75 percent. Consequently, this is causing detrimental effects on the fuel cost as well as the inflation. Despite having a high interest rate (15%) in Pakistan, exchange rate devaluation isn’t in control; although the detrimental effects of high interest rate are quite visible in the form of lower investments, absence of progression in almost all industries among others. This calls for a spontaneous, long-term strategic action from the government side at large to bring back the economy on track by lowering the interest rate.

Pakistan has been under the grip of debilitating exchange rate for quite a time now. In the midst of escalating political unrest and economic difficulties, Pakistan’s currency hit a new low against the US dollar, shattering all previous records. The interbank closing rate of one dollar on 1st August 2022 was 238.84 Pakistani rupees.

Pakistan’s current account deficit (CAD) increased significantly during the course of 11 months (July to May) in 2021/2022, according to the State Bank of Pakistan (SBP). According to data from the balance of payments (BoP), the current account deficit in the equivalent months of the previous fiscal year was $1.18 billion. The enormous trade imbalance caused by the sharp rise in import costs may be to blame for the current account deficit’s massive growth. According to figures issued by the Pakistan Bureau of Statistics, the country’s trade deficit jumped by 58.18% to $43.42 billion between July and May 2021/2022 compared to $27.45 billion during the same period of the previous fiscal year (PBS). Comparing the first 11 months of the current fiscal year to the same months of the previous fiscal year, the country’s import bill increased by 44.51 percent to $72.29 billion. However, export revenues also increased by 28% to $28.87 billion during the reviewed period from $22.57 billion during the same time of the previous fiscal year.

The increase in export revenue is primarily because of the performance of the textile sector in Pakistan. With exports rising from $12.5 billion just two years ago to nearly $20 billion now, the textile industry has set a new record. The implementation of the Regionally Competitive Energy Tariff (RCET), investments totaling more than $5 billion in development, and the establishment of 100 new textile facilities, which resulted in an increased export capacity of $500 million per month, all contributed to this tremendous boom. This doesn’t stop here, the sector has a potential to deliver $2 billion/month worth of exports, if provided with conducive environment.

In the upcoming fiscal year, textile exports are anticipated to reach $25 billion or more subject to energy availability at competitive rates. However, Pakistan will be obliged to look for additional $6 billion in loans from overseas, which under the current economic conditions would not even be doable, if this export momentum is lost owing to problems with energy supplies, cost restraints, and a crippling exchange rate.

In the longer run, the large devaluation of the rupee is worse for exporters especially textile exporters because it raises input costs, making exports less competitive. One of the biggest difficulties the sector faces is finding a steady supply of high-quality raw materials at reasonable rates.

Additionally, circumstances have developed that have caused Pakistan’s textile sector’s inputs, just like all of its other exporting sectors’ inputs to be measured in dollars in order to reduce the risks associated with currency volatility and to create a stable and secure environment for business. This includes raw materials, energy, dyes and chemicals, machinery, and spare parts, inter alia. Simply said, a country’s exports become less expensive and its imports become more expensive as its currency depreciates. However, in a globalized economy, industries are vertically linked, and exported goods often contain a significant amount of imported components. Therefore, imported inputs become more expensive for any given exporter and are not always interchangeable with domestically produced goods.

Aftab and Abbas (2012) concluded that exchange rate instability has significant negative relationship with sectoral export of Pakistan except waxes and animal oils, aircraft, transport equipment and arms. A negative indication indicates that a rise in relative price is to blame for the decline in export demand. Their study also implied that the textile and textile articles showed a negative sign. Arize et al. (2003) also concluded in his study that in both the short- and long-term, an increase in exchange rate volatility has a considerable negative impact on export demand.

Equally important is the fact that Exports rise in response to (real) currency depreciations and decline in response to (real) currency appreciations. This might not always be the case, though. Over a two-year period, a gain in exports of 4.9 percent results from a real devaluation of 10%. However, exporters adjust to the “new normal” just one-third as quickly after a depreciation as they do after an appreciation. Exports decrease more quickly following (real) appreciations than they do following depreciations because of supply limitations, pricing to market, and informational frictions (Varela, 2022).

After the rupee’s fall in 2018–19, Pakistani textile and apparel exporters did not increase export volumes. The primary explanation for this is that changes in profit margins stabilize export prices in the local currency, and this effect is accentuated during depreciations: US dollar export prices react to fluctuations in the nominal exchange rate by 15% more than they do during appreciations. The more the exchange rate changes, the more asymmetrically export US dollar prices respond, demonstrating that purchasers level out Pakistani rupee pricing.

If we look at Pakistan’s experience with rupee depreciation, we can say that it has always resulted in cost-driven inflation and relentlessly harsh economic conditions. Pakistan has suffered significantly from currency devaluation both as a buyer and a seller. Devaluation of the Pakistani rupee will result in a devaluation of Pakistani labor and talent on the global market, which will act more as a stimulant than a medicine and lead to unheard-of inflation.

It is time to abandon the widespread misconception that exporters welcome rupee devaluation and end the practice of favoring excessively undervalued currencies. The central bank and government should concentrate on achieving an exchange rate that is competitive in the market and achieves actual exchange parity. The policymakers should create the right conditions for a maximal export response to currency depreciations. This will enable a conducive environment for not only exporters in general but also the economy. There has been no concrete step taken so far by the government to put a halt to the ever depreciating Pakistani currency. Moreover, given present situation, we are not in any position to raise bonds and have no access to capital markets anymore. This is of grave concern.

The Pakistani government must support the exporters in their efforts to get ready for the impending challenge by keeping up with the evolving economic situation. It needs to support the export drive as the dollars earned through exports are the cheapest, more sustainable with the added benefit of no compulsion to return them, no interest, and still the cheapest with only 3-4% cost. Hence, focusing upon dollars generated through exports are far better option than bonds. Pakistan has to make a quantum jump, but even if it manages to improve its export performance through textiles, it may have a better chance of holding onto and eventually expanding sustainable, export-derived, dollarized revenue.

Shahid Sattar and Amna Urooj, "Exchange rate volatility and exports," Business recorder. 2022-08-03.
Keywords: Economics , World economy , Oil prices , Central bank , State Bank , Local currency , Dollar prices , Macroeconomic , Economy , Pakistan , CAD , PBS , SBP , US , RCET

Leave a Reply

Your email address will not be published. Required fields are marked *