Millions of Pakistanis will swarm the polling stations tomorrow to cast votes for the general elections. It would be second time in the country’s 70-year history that a government is democratically transferred. A huge part of debate around the elections has centered upon the economic issue of currency devaluation. The main opposition party brings up the topic on several occasions to charge at the incumbent. In this short essay I will share my opinion on the reasons behind the devaluation of the Pakistani rupee against the Dollar.
The Pakistani rupee has been devaluated from around 105 PKR/USD in Dec 2017 to around 130 PKR/USD in Jul 2018. Look at the history of PKR/USD exchange rate and the history of Pakistan's Foreign Exchange reserves in the images below. Observe that from Aug 2015 to Nov 2017, the PKR was stable at around 105. This period coincides with a time when foreign exchange reserves went up, reaching their highest level, and then started coming down. Why? This probably means that we started importing more (we are importing heavy machinery for the CPEC projects) and the global competitiveness of the export sectors declined (because of inefficient management of the economy). The real (market) price of the USD was below the peg to begin with (as indicated by increasing reserves after 2015) but it gradually creeped above it (the reserves started to decline by 2017), ultimately reaching a point where the peg could not longer be held.
See below image of the current account (Exports minus Imports) history: we are presently around the highest deficit. A country like Pakistan needs a healthy cushion of forex reserves to draw upon during an uncertain time or to stabilize exchange rate with another currency below the market price.
Another reason why rupee devaluation occurred is that Pakistan is gearing itself to follow a China-like model where an export-led growth is backed up by a devalued currency. How does that work? You keep your currency devalued so that imports become expensive and exports become cheaper. This way your trade moves towards a surplus from a deficit.
However, historically currency devaluations in Pakistan have lead to improvements in current account only in the short-run as they lead to an imported inflation in the long-run. How is that? As imports become expensive, businesses import at a higher cost and transfer it to the consumer in form of higher prices. This raises the general price level and once again, the exports start becoming uncompetitive in the global markets due to higher price - another devaluation is needed now.
I guess that the PKR/USD will reach 135-140 by the end of this year.
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