The current monetary and exchange rate policy of the State Bank of Pakistan (SBP) is the wrong response to our economic woes, which has put the economy on a path of self-destruction and made every citizen of this country poorer.
“Depreciations (as an economic policy) don't work. They have an economic effect, but they are not a good economic strategy. It is how you make yourself poorer”. I’m not saying that. It was stated by Mark Carney, Governor Bank of England, while explaining to the UK Parliament in 2018 that a sharp decline in the value of the pound as a result of Brexit can have disastrous negative consequences on the country as a whole.
A 40 percent depreciation of the rupee over the last eighteen months was the wrong tactic to tackle the deep-rooted current account crisis facing the economy. After more than a year, there is compelling evidence the sharp decline in the value of the rupee has accelerated the economic downturn and made the whole population of the country worse off.
Make no mistake. The rupee was overvalued and an immediate and sharp reduction in our current account deficit was required. Imports needed to be curtailed abruptly. We were living beyond our means, gulping down cheap imported goods when we didn’t have the foreign exchange to pay for them. That had to be stopped.
Also, a correction in the artificially inflated exchange rate was necessary. Holding it artificially pegged for the last four years without the underlying fundamentals supporting it was a disastrous policy and the reason we are in this mess. But the correction needed to be less dramatic and phased-in, giving clear indications about the future direction and parameters of the exchange rate policy. Raising tariffs, imposition of regulatory duties, and import restrictions on non-essential items would have curtailed the import bill immediately. A gradual exchange rate adjustment would have given the economy and stakeholders time to adjust with the new reality. The sharp 30 percent reduction within 12 months (with no end in sight) has permanently shaken the confidence of businesses, consumers, domestic and foreign investors, and lenders and borrowers. The devaluation has added Rs3.4 trillion to our national debt and dramatically reduced our repayment capacity. More consequentially, it has put in question the long-term sustainability of the economy.
The theoretically-inspired hawks, who argued the weaker rupee would result in a boost in exports and there will be benefits of this depreciation, have already been proven wrong, demonstrating these text book economists hardly know anything about this economy.
Ours is an import-based economy. A weaker rupee has caused inflation to spike because imports are now more expensive. Unfortunately not all imports are frivolous or luxury items. They are also our staples. Our biggest imports are petroleum products for our transportation, power plants and refineries; LNG, coal, medicines, chemicals, fertilisers and so on. The list is long. Most industrial production in the country depends heavily on imported raw materials. Almost all large-scale manufacturing (LSM) plants and machinery, capital equipment, tools are imported - items needed to keep this economy moving, costs of which are based on the rupee-dollar parity. Making these essential raw materials 40 percent more expensive, has trickled down to every consumer in the country, pushing the inflation to 11 percent.
The sharp rise in prices of food items, medicines, utility charges, fuel and the overall higher cost of living has forced millions into poverty. But it has also hurt the middle- and upper-middle class in a profound way - dramatically shrinking their disposable incomes and purchasing power, sharply curtailing domestic demand and pushing many businesses to the brink of collapse. Steep fall in retail sales numbers, fall in sales of automobiles and consumer electronics is a clear indicator of the evaporation of consumer demand -raising unemployment as a consequence – further squeezing demand. Reinvigorating domestic demand is the only, repeat only, way to kick start the economy and prevent it from hurtling further into deep recession. Any attempt to pin hopes of a recovery on foreign investors or grand bilateral investments are nothing more than a fool’s dream. The fire that fuels this economy always has been and will remain strong domestic demand from our 225 million-strong populace. The cost-push inflation unleashed by devaluation has killed domestic demand.
The falling rupee has also shaken the confidence in the economy among foreign investors. Investors, who showed confidence bought into the growth story and invested in the economy in the last few years, have seen an overnight fall in the value of their Pakistani assets and portfolios.
And the promised export boom did not come either. The textile exporters, as always, did not deliver (as they haven’t for the last three decades)! Finding excuses for their abject failure to take advantage of the massive rupee devaluation, the powerful lobby will undoubtedly contend they were hamstrung by the increased cost of doing business, increase in sales tax, energy and raw material costs. That may be true. But the simpler truth is there’s no depth in our textile industry. Our textile mills don’t produce enough of what the world wants or of the quality and at the price it wants. Textile exports have long lacked product and market diversification, value-addition etc. The list of failures is long. And what we do make well, we don’t make enough off of it. That is because our industry lacks scale. The reality is that we have no exportable surplus in most commodities. We lack adequate processing and finishing facilities in almost all sectors even where it requires very little processing, for example for naturally available materials like marble and minerals.
The truth is even our economy is shallow. We can depreciate the rupee by another 30 percent and there still won’t be any significant jump in exports. Our manufacturing base is obsolete and depleted. We’re uncompetitive, technologically deficient. Our factories lack scale to produce cheaply. Our value chains are unsophisticated. Our supply chain and logistics infrastructure is broken and inefficient. Our share in global exports has been falling continuously for the last two decades. Equally disturbingly, the share of manufactured goods in our exports is falling even more rapidly. Amusingly, the rising cost of imported items has also created opportunities in many sectors for import substitution. But capitalising on these opportunities for exports and import substitution requires sustained investment in new manufacturing capabilities. We desperately need new investment in technology, up-gradations, modernisation, scale, value-chains which, incidentally, also create jobs!
That’s what we need. But that’s not what the SBP wants to see. With the central bank’s current policy of maintaining record high policy rates, ostensibly to attract hot money, it’s impossible to foresee any long-term investments in any sector, let alone the painstaking process of enhancing manufacturing productivity. Nobody in their right mind will borrow to invest in the current monetary policy environment, where the policy rate is 13.25 percent. The sharp rupee depreciation and the high cost of credit have made it impossible to make these much-needed investments in our industrial and infrastructural bases, desperately needed to lift our economy and people. All private investment is on hold. Neither new projects are coming online, nor are new jobs being created. And this shall remain the case until the SBP signals a clear shift in its monetary policy and the policy rate sees a sharp reversal.
And even if some daring entrepreneurs would consider making new investments, where would the finances come from. The high yields on Pakistan Investment Bonds and the incessant government borrowing from commercial banks have crowded out private sector borrowing. Most banks have already stopped lending to new clients, reducing limits for existing borrowers and drastically reducing long-term credit to medium and large businesses. Understandably, why would banks make riskier private sector lending when they can lend risk-free to the government at such attractive yields.
The economic events of the last year have permanently altered Pakistan’s risk matrix for both domestic and foreign investors. A decline of more than 30 percent in the rupee value and a 100 percent rise in interest rates in a span of just 12 months, has shocked investors to the core and permanently reinforced the perception this is an unpredictable and unstable economy, where seemingly unimaginable economic scenarios are possible. With this risk perception, amid this uncertainty and instability, and a looming recession, the SBP should be signaling an expansionary monetary policy, facilitating long-term investments and stimulating domestic demand. Instead, it has singularly focused all its efforts on keeping the policy rate high to attract institutional portfolio investments. This is a destructive policy. If not reversed soon, it risks pushing this economy into a long cycle of deep recession, high unemployment, and inflation.
The writer is a business leader