In a span of just a few days, the value of the Pakistani rupee has fallen from Rs123 to Rs128.75 against the US dollar. Many have wondered why this has happened.
To begin with, it has nothing to do with international market fluctuations. The drop in the value of the rupee is among the series of remedies that the caretaker government intends to take in order to avoid a potential bailout from the IMF. But why do we need a bailout in the first place? The foreign exchange reserves of Pakistan have been depleting at an alarming rate and the fiscal deficit has been soaring.
The preceding government estimated that the fiscal deficit of 2018 would halt at 5.5 percent. But to their dismay, it has soared to 6.8 percent. Similarly, the fast-depleting foreign exchange reserves can only meet the need of imports for three months at best. To make matters worse, the aggregate demand in the country has been skyrocketing, which means that the overall demand for goods and services has been increasing. In order to fix these bottlenecks, the government may take several remedial measures.
Let’s examine each of the possible steps that the government could take in order to avoid an IMF rescue. First, what the government can do – and has, in fact, recently done – is depreciate the currency. When the value of local currency falls, it makes the exports competitive in the international market and simultaneously makes the imports expensive. There hasn’t been an official statement from the State Bank on a deliberate devaluation of the currency so far. But given the past trend on four consecutive devaluations of the rupee that have been orchestrated by the State Bank since last year, it is likely that this too was another desperate attempt to halt the worsening fiscal deficit. This was potentially done with the intention to reduce aggregate demand so as to lower the import bill and aggrandise exports. This, in turn, is set to bring a positive effect on the overall balance of payment and reduce the fiscal deficit.
Second, the government can possibly put additional taxation on inelastic goods (where the demand doesn’t change by much in relation to a price hike). For instance, the two most inelastic products are energy and fuel. Taxing these will relatively ameliorate the public revenue base and will have an adverse effect on the fiscal deficit. However, this doesn’t come without impediments for the economy. Taxing energy and fuel can put pressure on small- and medium-sized enterprises (SMEs), other corporations, and consumers. This could close a possible income-generating window in the economy.
Finally, the government can adopt an adverse monetary policy by cutting down its spending – both current and capital. A sharp cut in such spending can have a negative impact on the rising aggregate demand. Ceteris paribus, a cut in public spending will lower economic growth and inflation in the country. Consequently, this will lower the demand for imports and help stabilise foreign exchange reserves.
The aforementioned steps of depreciating the local currency, taxing the inelastic goods, and cutting down government spending are some monetary policies that the government may adopt in order to avoid yet another rescue from the IMF. However, these steps certainly come at a cost and must be thought through before they are implemented.
The writer is a YoungDevelopment Fellow at the Ministry of Planning,Development and Reform, and an associate researcher to the chief economist of Pakistan.