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August 27, 2015



Devaluation and the ego

There is a sense amongst many prominent policymakers in Pakistan, particularly the finance minister, that Pakistan’s currency, in particular its exchange rate, is a sign of one’s ego. Official statements such as: ‘we will never let Pakistan’s rupee depreciate or devalue’, or that ‘we will protect the rupee at every cost’ show that Pakistan’s senior most policymakers are concerned more with some old-fashioned notion of image or ana (ego), and that too, a false one, rather than the fundamentals of economics.
After taking over as finance minister, Ishaq Dar ‘successfully’, if that is the right term here, showed how he could improve Pakistan’s rupee/dollar rate from around Rs104 to Rs98. Economic fundamentals be damned, and Maula Jatt’s danda reigned supreme.
There are two fundamental issues which revolve around any decision about Pakistan’s exchange rate at the moment. The first is that it is not the business of the finance minister or his ministry to set the rupee exchange rate. No matter what the finance minister’s ego determines, the exchange rate is determined by the central bank, the State Bank of Pakistan. The State Bank is required to monitor and manage the rupee rate keeping in mind numerous factors.
Pakistan’s central bank is supposed to be independent and is not supposed to follow the directives and desires of the finance minister. Clearly, by setting the exchange rate, the finance minister and his team have been trodding on the domain of the State Bank of Pakistan.
While egos have played a part in the decision to lower the rupee/dollar rate, it is supposed to be economic fundamentals with regard to the balance of payments, foreign exchange reserves, and how Pakistan’s main competitors are dealing with their currencies, that ought to determine how the rupee is to be traded. Again, this is the domain of the State Bank of Pakistan, which holds Pakistan’s foreign currency reserves and is responsible for making

foreign transactions.
There are a large number of experienced and well-trained economists in the State Bank of Pakistan who follow these trends and who are aware of where the rupee/dollar rate ought to be today. However, with a dominating finance minister, all economic evidence whittles away in front of a large ego. When the finance minister insists that the rupee has to be brought down to Rs98 a US dollar and puts his reputation at stake, who needs a PhD in Economics.
In the last few weeks, not only has the rupee slipped (in terms of the ego), or stabilised and reflected a more real value than an artificially maintained one (if one considers economic fundamentals), but there has also been ample debate in the media about whether Pakistan should devalue the rupee further. Even untrained television anchors have jumped into the fray and given their own perspective and held ‘discussions’ about what they think the rupee/dollar rate ought be, misinforming the public, playing in to the ego narrative. Fortunately, however, some serious economists have also written about what economic fundamentals suggest.
Perhaps the most intelligent and sophisticated analysis has come from Pakistan’s preeminent economist, Hafiz A Pasha, who examines economic issues rather than wishes and desires. Hafiz A Pasha quotes evidence from the State Bank of Pakistan showing that ‘the rupee is now overvalued to the extent of 18 percent’. This means that rather than Rs98 or even Rs104 which it is today, the dollar should be at around Rs122, if one looked at real economic factors.
Moreover, Hafiz A Pasha also looks at other factors, especially the fact that Pakistan’s trade competitors have substantially devalued their currencies. He writes that of those who have devalued, India has done so ‘by 6 percent, Indonesia by 15 percent, Thailand by 9 percent, Turkey by 30 percent and Vietnam by 3 percent’, and of course, the Chinese yuan has also depreciated around 4 percent. For Hafiz A Pasha, looking at other economic factors such as input costs, the rupee should be depreciated or devalued by around 6 percent, which would mean a dollar at around Rs109.
Whatever the optimal rate or range for the rupee/dollar is, and all signs suggest that it is overvalued, if the State Bank of Pakistan (and certainly not the finance minister) wanted to devalue it, they should look at the evidence and decide. There are well-understood negative consequences of devaluation as well which will be factored in, but the fact that Pakistan’s import bill has fallen suggests that a devaluation may not have a huge impact on the current account or the balance of payments. This is so because of the huge fall in oil prices globally – today they are lower than $40 a barrel, the lowest in six-and-a-half years. With low inflation and low interest rates, and with oil constituting more than a third of Pakistan’s total import bill, if devaluation is to take place this is the best time for this to happen.
One must add, however, that the perception that a devaluation will necessarily increase Pakistan’s exports, which many exporters, particularly APTMA, are suggesting, is not borne out by empirical evidence, and any decision has to be carefully thought through. Nevertheless, whatever the eventual decision, let competent and trained economists decide, and the institution whose mandate this is take appropriate measures, not those who live in the world of the ego.
The author is a political economist.