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Rupee erosion and who benefits

The pace of the rupee erosion left Pakistanis bewildered with the vast majority of analysts terming it against national interest as well as against the interest of the common man given that our economy is heavily dependent on imports of oil and products to run the transport as well as the energy sector – two sectors that have a major impact on inflation. A standard normal condition for extending support by international lending agencies like the International Monetary Fund (IMF) is to compel the government not to intervene in the currency market and allow it to reach its natural equilibrium. This, if achieved, it is argued would end speculation in the currency.

The Pakistani rupee witnessed massive erosion in value till the State Bank of Pakistan (SBP) intervened in the market on the instructions of Governor Yasin Anwar who was in China at the time. But non-compliance of any single IMF condition is not a deal breaker. However the IMF is also focused on the real effective exchange rate (REER) as well as the nominal exchange rate. The latter is a simple concept and implies the rate at which a currency is being traded for another, for example, 106 rupees would get one dollar. The REER is the product of the nominal exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. The concept is used for a wide variety of purposes, such as assessing the equilibrium value of a currency, the change in price or cost competitiveness, the drivers of trade flows, or incentives for reallocation production between the tradable and the non-tradable sectors. Certain developments like foreign capital movements, changes in the terms of trade or productivity increases due to technological innovations do cause alterations in the real value of the exchange rate. Such movements, economic theory maintains, are the consequences of the functioning of the economic laws.

Looking at the past four years, the IMF statistical annexe for Pakistan available on its website indicates that the REER (annual average, percentage change) in 2009-10 was 0.9 percent; the year after the PPP-led coalition government signed the Stand-By Arrangement (SBA) with the IMF. All time bound conditions were met during that year under the stewardship of Shaukat Tarin who took on an additional amount as bridge loan, in case the 5 billion dollar pledges made during the Friends of Democratic Pakistan meeting in Tokyo might not materialise. By 2010-11, the situation improved to give a REER rate of 6.1 percent followed by 2.7 percent in 2011-12 with Dr Hafeez Sheikh unable to deliver on pledges made by the government under the SBA.

Last fiscal year, the decline in the REER was attributed to an election year where economic decisions were subordinate to politics and the rate plummeted to negative 6.2 percent. The Extended Fund Facility (EFF) requires the rate to be no more than negative 7.7 percent in the current fiscal year – an objective unlikely to be achieved given the government’s stated intent not to focus on domestic inflation in the current year. The REER will be lower than the negative 7.7 percent if the government does not receive the pledged assistance and more disturbingly the 3.5 billion dollars it anticipates as the outcome of the EFF programme by the end of the three years. But a declining currency value, nominal or REER is not always a bad thing in economic theory. In the event of falling exports a depreciating currency would render exports more competitive internationally. And make imports more expensive with an in-built mechanism that would discourage unnecessary imports. Or in other words, depreciation of a currency may increase exports, reduce imports and thereby generate a more favourable balance of trade with higher international reserves.

The question is whether Pakistan is currently in a position to take advantage of these positive fallouts of depreciation. And unfortunately the answer is in the negative. Pakistan’s exports remain hostage to not only law and order issues in the country, which are also a mitigating factor in attracting foreign investment, but also load shedding which continues to act as a deterrent to productivity. In addition, our exports are now being subjected to higher input costs due to a massive rise in the electricity bill as well as higher transport costs due to escalation in price of petroleum and products as well as higher imported inputs (for those productive units that are reliant on imports given the depreciating rupee). And most disturbingly the tax measures imposed in the 2013-14 budget are anti-productive activity as they focus on raising revenue through enhancing taxes on existing tax payers while abandoning all measures designed to bring the large undocumented sector into the tax net or impose a tax on real estate transactions. If one takes account of global recession whereby demand for consumer items are on the decline, Pakistan’s major export items, both internal and external factors are mitigating factors in an attempt to raise exports.

However, not all exporters are losers with a rupee depreciation. Nawaz Sharif remains equally enamoured of a particular businessman’s ability to run businesses very successfully and it has been reported that that businessman has attended several high-level meetings focused on ways to resolve the power crisis as well as providing critical input in the formulation of policies designed to encourage the private sector to play its due role in economic growth. And while Mawaz Sharif’s friend’s supporters may argue that grapes are sour yet for his critics there is danger of a conflict of interest arising. He owns power companies and Ishaq Dar, the Finance Minister, while chairing the Cabinet Committee on Privatisation on Thursday, announced power companies would be among the 31 to be privatised (including well-run profitable companies like Iesco). The mode of privatisation was left to the Privatisation Commission which has indicated it would vary from strategic partnership that maybe challenged in a court of law to sale of 26 percent shares on the open market to any other mode.

However, the state of the economy and the bitter pill in terms of higher utility prices as well as enhanced taxes on existing taxpayers that the public is being asked to swallow by the Dar-led economic team warrant that all sales of public sector entities be above board, transparent and with not even a hint of conflict of interest. Additionally, there is a need to offload the badly run loss making companies first to ensure that the drain to the treasury in terms of bailout packages is plugged – a drain estimated at 500 billion rupees plus per annum.

Anjum Ibrahim, "Rupee erosion and who benefits," Business recorder. 2013-10-07.
Keywords: Economics , Economic system , Economic issues , Economic policy , Economic growth , International economics , Price hike , State Bank , Privatisation , Taxation , Inflation , PM Nawaz , Pakistan , REER , IMF , SBP