The aftershocks of a fallen rupee

Published 26 Mar, 2019 07:26pm
A cargo container being loaded at a port | Reuters
A cargo container being loaded at a port | Reuters

A university lecturer in Karachi has been saving money since 2017 to buy a new car. She planned to save around 700,000 rupees, sell her old car for about 400,000 rupees and use the total amount to buy a Suzuki WagonR of the latest model. Many months later, she is still driving a dilapidated Suzuki Mehran car that does not even have an air conditioner.

Prices for new cars rose every couple of months after the start of 2018, she says. The basic version of WagonR has become costlier by 200,000 rupees. Bigger cars, such as Honda City, Honda Civic and Toyota Corolla, are selling for up to 500,000 rupees more than they did at the end of 2017.

Every time prices increased, the lecturer needed to save more. This has not been easy given her fixed monthly income. She says she “could not come up with additional money immediately after every price hike”.

Automobile manufacturers were raising car prices in response to multiple decreases in the price of the Pakistani rupee vis-à-vis other currencies. These decreases rendered all imports – including automobile parts – costlier for local manufacturers and consumers.

Asad Zaidi, who works as a bank manager in Karachi but also imports automobile parts from China on the side, says his business has shrunk in order to cope with the decrease in the rupee’s value. “We heavily scaled back on the volume of our imports,” he says.

Expecting more devaluations to come, he is maintaining a cushion of 10-12 per cent over and above his profit margin in the sale price of his imports. This only means his customers have to pay far more for the same parts than they did a year ago.

Even bigger importers are hurt by changes in the rupee exchange rate. Tahir Ahmed, chief executive officer of Lucky Commodities, one of the largest coal importers in Pakistan, says his company suffered losses throughout 2018 on account of sharp changes in the exchange rate.

There is usually a lag of a month and a half between the placement of an order and the actual arrival of a coal shipment, he explains. By the time his shipment arrives at a port, he has already sold it to local customers on the currency exchange rate it was booked on but he will still have to pay port handling charges in dollars on the current exchange rate. “This messes up my costing,” Ahmed says.

His problems have been compounded due to the fact that banks are actively discouraging forward cover — that is, placing an order today on a mutually agreed exchange rate for a shipment that will arrive six months later. Banks discourage this practice so that importers do not rush to make large-scale forward bookings as a means to avoid the negative impact of future rupee devaluations. If they do rush, that will lead to a big exodus of foreign currency from Pakistan — a situation that will have further negative impact on the rupee’s exchange rate.

The exchange rate is determined by the demand and supply of foreign currencies, especially the American dollar, in an economy. Exports are a primary source of foreign currencies coming into a country — as are remittances by expatriates, foreign direct investment and loans obtained from other countries and multilateral financial institutions. Imports and servicing of foreign loans, on the other hand, result in foreign currency going out of the country.

Since Pakistan imports way more than it exports and its debt servicing has far exceeded the foreign loans and foreign investment it has attracted in recent months, it has been running short of dollars to pay its foreign bills. The rupee’s value vis-à-vis other currencies, consequently, has gone down massively.

The only sustainable way of keeping the exchange rate stable is to grow export earnings at a rate that outpaces the increase in demand for dollars in the economy. Pakistan achieved that stability between 2002 and 2007 when – thanks to the doubling of exports and windfall foreign currency inflows in the wake of 9/11 – the price of the American dollar remained stable around 60 rupees.

Analysts in Karachi believe a major downward adjustment may not be needed — at least for the time being. According to them, the rupee-dollar parity is already close to where it should be.

When Ishaq Dar was Pakistan’s finance minister between 2013 and 2017, he also ensured that the dollar’s price stayed around 105 rupees. This stability, however, was fundamentally different from the one that was obtained in the previous decade.

Since exports remained stagnant during Dar’s tenure, he tapped all other avenues of foreign currency inflows — including a loan from the International Monetary Fund (IMF), bilateral loans from friendly countries, bond auctions in foreign markets and the privatisation of state-owned enterprises. Pakistan’s foreign currency reserves, as a result, hit an all-time high of 24.4 billion US dollars in October 2016. 

This was also an IMF conditionality: if Pakistan wanted to ensure that it continued receiving tranches of its IMF loan, it was required to keep building its foreign currency reserves.

So what did Dar do with those reserves? He ploughed them incessantly in the foreign currency market to keep the dollar price at an arbitrary level of 105 rupees. “For some inexplicable reason, he was fixated on keeping the exchange rate at 105 rupees,” says a State Bank of Pakistan official who frequently interacted with the federal finance ministry when Dar was heading it. “Every time there was even a slight movement in the exchange rate, our team would fly to Islamabad – sometimes even on Sundays – to explain its reasons to the finance minister,” the official reveals.

Consequently, the State Bank of Pakistan would set a daily level for foreign currency transactions and informally tell treasury managers of banks not to cross it. Whenever there was a higher demand for foreign currency, the central bank would take out dollars from its own coffers and sell them in the interbank market. This would maintain the exchange rate at 105 rupees.

Injection of dollars by governments or central banks to keep the exchange rate stable is nothing unheard of. Stability is important for every economy and stability in foreign currency markets guarantees that there are no shocks in foreign trade and foreign loan servicing. But, typically, this strategy works best when exports are expected to keep growing in the short to medium term. Dar’s obsession with foreign currency rates, on the other hand, coincided with a prolonged stagnation in Pakistan’s exports.

The obvious reason for a sluggish growth in exports is that the corporate sector is finding it more profitable to do business locally. Many big business houses in recent years, indeed, have diverted their attention from the international market to expand locally, says Salim Raza, a former governor of the State Bank of Pakistan.

Well-established conglomerates, such as Lucky Cement, Packages Group, Nishat Group and Arif Habib Group, have all entered businesses like retail and construction that cater to local consumers. Some of them have set up huge shopping malls although they could have expanded their export-oriented businesses — such as textiles.

So what did Dar do with those reserves? He ploughed them incessantly in the foreign currency market to keep the dollar price at an arbitrary level of 105 rupees.

Kaiser Bengali, a Karachi-based economist, verifies that there is a stronger focus on domestic markets among Pakistani businesses. In a recent study published by the Sustainable Development Research Centre, a think tank affiliated with the Shaheed Zulfikar Ali Bhutto Institute of Science and Technology, he says growth in imports in recent years has been far higher than that in exports. In the 1990s, according to him, average annual growth in exports was 6.1 per cent whereas average annual growth in imports during the same decade was 4 per cent. While exports have grown at an average rate of 7.5 per cent annually in 2000-2015, he says, imports in the same years have surged by an average annual rate of 11.4 per cent.

Former State Bank of Pakistan Governor Dr Ishrat Husain wrote a front page article in daily Business Recorder in the first week of October 2017. Dar was finance minister at the time and the dollar price hovered around 105 rupees. Almost everyone who knew a thing or two about economics and finance was clamouring for a rupee devaluation.

Husain argued against devaluation. Calling it a “blunt instrument”, he said devaluation would slow down economic growth, increase inflation and hurt job creation. He went to the extent of advising experts to “hesitate from making” statements about the issue as it could “confuse the economic players”.

According to Husain, devaluation does result in a short-term spike in export earnings but its effect is neutral in the long run. For one, foreign buyers will demand at least a 5 per cent price discount if a 10 per cent devaluation takes place, he argued. Additionally, he said, 40 per cent of Pakistan’s exports use imported raw materials which will become expensive with rupee devaluation. The net gain for exporters of a 10 per cent devaluation will be only 2-3 per cent, he stated. But, as he pointed out, devaluation increases inflation, raises prices of daily use items and, therefore, hurts the poor the most because wages do not always increase in line with the increase in prices.

As expected, the article drew a barrage of criticism. In a front page response in the next day’s edition of the same newspaper, former finance secretary Waqar Masood Khan wrote that Husain was missing “the fundamental point” that maintaining an unrealistic exchange rate drained the country’s foreign exchange earnings that should otherwise be used for financing the current account deficit.

A month later, Dar resigned. His successor took less than a month to reverse his exchange rate policy of four years. Five rounds of major depreciations later, the exchange rate now hovers around 140 rupees — with the local currency having lost more than 33 per cent of its value since November 2017.

Eid shoppers in Lahore | Murtaza Ali, White Star
Eid shoppers in Lahore | Murtaza Ali, White Star

This rapid devaluation has left some businesses struggling. While the cost of production has risen for almost everyone, some are suffering more than others because they are unable to pass the impact to consumers due to regulatory price controls and competition, says M Abdul Aleem, a senior representative of a caucus of 189 multinationals operating in Pakistan.

He acknowledges that devaluation was a necessary, though painful, step but argues that it could have been managed in a gradual manner. “Rapid devaluation together with increased interest rates has hurt business confidence.”

News reports suggest that the IMF is pressing the government to adopt a free-floating currency exchange rate as opposed to a managed one that exists right now. The government is apparently resisting the suggestion in order to avoid extreme and sudden exchange rate movements that may result from a free-floating mechanism. It wants to continue with the existing system but, unlike Dar, it is flexible towards making downward adjustments as and when needed.

Analysts in Karachi believe a major downward adjustment may not be needed — at least for the time being. According to them, the rupee-dollar parity is already close to where it should be.

They have arrived at this conclusion by using a method that IMF deploys to assess the real value of a currency. Called the “real effective exchange rate” – or REER – it measures the value of a country’s currency in relation to the currencies of that country’s major trading partners.

“With REER now hovering around 99.08 (a value of 100 means the prevailing exchange rate is justified), we believe the era of major currency moves is behind us,” reads a recent research note prepared by a brokerage house, AKD Securities. It, however, does not rule out a 3-5 per cent devaluation in the coming months, with the dollar rate settling at 145 rupees by June 2019.

The writer is a business journalist associated with Dawn.

This article was published in the Herald's March 2019 issue. To read more subscribe to the Herald in print.