Sunday September 24, 2023

Paradox of devaluation

August 16, 2022

Global imbalances, trade resets, a polarized world, fault-lines and war in Europe have disrupted trade dynamics, sending commodity prices spiraling, in some cases, to levels not seen before.

We are witnessing a rapid erosion of purchasing power across the world but more so in emerging markets, particularly those that rely heavily on imports. Nearly every market, except for a few, have witnessed currency depreciation of varying degrees – to name a few: the Indian rupee/$ at 7 per cent, Bangladesh taka/$ at 10 per cent, Malaysian ringgit/$ at 6 per cent. However, in our case, the shifting sands have altered the currency landscape in ways that have left everyone aghast – 35 per cent devaluation during the first seven months of 2022.

The release of the IMF tranche, post its board approval, is said to be the trigger that will convince other lenders to come forward with their support. This debt inflow is expected to ease pressure on the rupee and clear pending and future foreign currency payments for the year. However, these are short-term solutions to plug the foreign currency gap; we will, in due course, need to repay all this, not to mention the interest that these will attract and for which we will have to borrow more and thus the vicious cycle will continue. One can always hope for a miracle in which US dollar floodgates open, wiping accumulated debt from the recent past or commodity prices drop drastically. But this is not something the nation can or should depend on.

While the freefall of the rupee that occurred in the first place may be perplexing, it may suffice to say that events over the past few months – and more so over the past few weeks – have raised serious concerns in the minds of many about the country’s economy. The depreciation of the currency, fueled by economic and political uncertainty, has sent shockwaves across the financial markets forcing international rating agencies to downgrade Pakistan’s short-term rating outlook, and subsequently affirming the long-term rating at B-. The manner, speed and extent of the freefall of the once-cherished South Asian currency begs the question: has devaluation become a business?

Around 50 per cent of the total tax revenue on average over the recent years is derived from imports. Each rupee fall against the US dollar gives the exchequer around Rs15 billion on a running 12-month basis. The rupee fall from January, 2022 to June 30, 2022 has given an additional potential inflow of around Rs425 billion for the six-month period while devaluation from July 1, 2022 to August 12, 2022 has added a potential Rs160 billion to the exchequer for this brief period and if the devaluation continues at these levels then until end December 2022 it will be around Rs850 billion. Thus, achieving budgetary targets should be a no-brainer. Shortfall, if any, is and will most likely be filled by borrowing more, taxing those who are already taxed or slapping another one-time supertax on corporates – game set and match!

Exporters benefit as well – hands down, as some would say. Some importers pass on the costs, some benefit from their inventory while those who do not benefit, complain bitterly about banks making money, wherein the real beneficiaries are someone else. Those with US dollar assets abroad go about merrily living their lives but join the complaint chorus. It is 210 million Pakistanis who suffer and will eventually pay the price for the US dollar indebtedness that only grows every year. But then who cares? Sadly, no one.

Elections are won and lost on campaigns that evoke ills of the past and promise a better future. The show goes on. It has been going on, after all, for decades now. Is this then, not the time to pause, reflect and course-correct? Wearing debt shackles will not ease the suffering, it will only compound our miseries. Our import vs export ratio is 50 per cent, while the ratio of exports to our GDP is 10 per cent. Our neighbour on the eastern border hovers around a 91 per cent export to import ratio while Bangladesh is at 62 per cent. An industrial power such as China is at 121 per cent while Vietnam is enviously at 101 per cent even after a two-decade war that had left them ravaged. To contextualize: average data of the past five years shows that we fund our imports to the extent of nearly 49 per cent through exports, 37 per cent through remittances, 4 per cent through investments and nearly 10 per cent through foreign currency borrowings.

While increasing exports is, and must be, a central goal, bridging the trade gap via borrowing or via foreign investments (unlikely in the current environment) or an asset sale (not advisable at these throwaway prices) will remain the norm unless we curtail imports. Some might argue that this will impact growth, which it may to an extent, but then the question is: what is the choice? Borrow more and keep borrowing more?

A cursory look at our import breakup will clearly show areas which can be taken head-on and reduced. Surely, we could do with lower oil consumption, less luxury imports and rationalization of items which are non-essential. A balanced policy of matching imports versus exports and remittances could reduce the need to reach out to friends and allies with a begging bowl, thereby building investor confidence to attract essential foreign and domestic investments that will contribute to a sustainable future.

In a world where speculation is rife and disinformation is a business, it is easy to capitalize on the freefall of the rupee, which can be stopped by understanding the dynamics of money flows and taking dispassionate, selfless and difficult decisions. Capital formation is not a crime but keeping policy frameworks the way they are, or not doing anything about it at the cost of the 210 million Pakistanis certainly is.

The writer has been in the financial services industry for nearly four decades.