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The impact of free fall of rupee

The Pakistani rupee continues to weaken against the US dollar after the central bank withdrew its support earlier this month. The local currency has plunged to record low against the dollar as it is presently being traded at Rs107-110 for a dollar in the interbank market. The rupee, which has mostly traded in a tight range of 104-105 per dollar since December 2015, shed over 5 percent in the past three sessions last week. Market analysts predict that the rupee is likely to settle somewhere from 110 to 111 and they believe that it would not be allowed to pass Rs112 to a US dollar.

The withdrawal of support by the State Bank of Pakistan (SBP) for the rupee was seen as a devaluation measure as the central bank is the biggest player in the thinly traded local foreign exchange market and controls what is widely considered a managed float system. The central bank said in a statement that a weaker rupee would help the economy grow and ease balance of payments pressures. Analysts believe that with no intervention from the central bank it has been left up to the market to determine the rate. The experts have been urging the government to devalue the rupee, as it was hurting exports and contributing to the depletion of the country’s foreign currency reserves.

The rupee is presently being traded at around Rs107 to a dollar in the interbank market. During the four years of coalition government led by former prime minister Yousuf Raza Gilani, the rupee registered 46 percent decline since March 25, 2008 when it was traded at Rs62.61 to a dollar. The rupee depreciation is attributed to the erosion of foreign exchange reserves, drying up of foreign investments, no inflow of loans from international donor agencies and a widening trade deficit. The analysts believe that weak economic fundamentals and slowdown in foreign investment has actually brought the rupee under pressure.

The persistent depreciation of rupee is likely to fuel inflation. The high inflation will not only hit the poor hardest but it will also affect all segments of the economy. The poor and the lower middle class find it increasingly difficult to make both ends meet with soaring prices of essential commodities including foodstuff. The poor are highly sensitive to the price changes in food, particularly staple food items. Households struggling to meet the minimum standards of living might have no choice but to cut down their expenditures on health and children’s education. Low inflation provides the central bank a cushion to slash its benchmark interest rate to spur economic growth. Soaring inflation has not only raised the credit price but also weakened the purchasing power of the people. The experts argue that higher discount rate and inflation is positively related. However, the solution lies to bring down food inflation with augmenting the supply of food, improving governance and distribution networks.

Depreciation of rupee is likely to have repercussions for the government’s total debt, which would automatically increase because the public debt is presented in the rupee terms. The experts believe that devaluation of Rs1 causes Rs60 billion jump in the public debt burden. A hugely indebted nation could face serious problem in meeting its budgetary targets and the interest repayments ahead.

 

The growth of per capita income depends upon stability of the exchange rate. The country’ per capita income, calculated on the basis of an exchange rate of Rs61.30 to a US dollar, increased from $926 to $1,085 in the fiscal year 2007-08. The currency’s strength against the US dollar was instrumental to push up the per capita income in the year 2007-08. With a population growth at 1.9 percent per annum, the country’s real GDP growth of less than 2 percent indicated a negative growth in per capita income in the fiscal year 2008-09. Presently rupee has depreciated to around Rs107 to a dollar, which means negative growth in per capita income.

Devaluation of rupee against all major international currencies is the reflection of weakness of the economy. The rupee had been stable since the government received the first loan tranche of $3.1 billion sanctioned by the IMF in November 2008, but increased demand for dollar by importers over the past four years has taken its toll on rupee’s health. Under former government of Prime Minister Shaukat Aziz, the foreign exchange rates witnessed stability and the rupee did not lose its value against the US dollar and remained at Rs.61 to a dollar, which is presently valued at Rs.107 to a dollar.

The decline in exports is also witnessed in terms of rupee despite the fact that the massive depreciation of the rupee against the US dollar in the past. This shows that the depreciation did not support Pakistani commodities to penetrate in the international markets. Local textile makers are concerned over the continuous depreciation of the rupee that has increased production cost of export goods, making their products uncompetitive in the world market. The rupee slide has made the imports particularly the oil imports, costlier. The government raised fuel prices from due to depreciation of the rupee, though price of oil in the international market was relatively stable.

Non-intervention of the country’s central bank in the market operations denotes that the central bank has allowed the rupee to slide against the greenback in a move to boost exports. The gains on export front however will be short term in a country where export-oriented industries heavily depend on imported raw materials. Increased remittances from Pakistanis working abroad supported the rupee and shielding the currency from a sharp fall but the increased dollar demand continued to push the rupee lower. The rupee is also in a free fall owing to the widening current account deficit, excessive government borrowing, drying up foreign flows, increasing oil imports, and repayments to the IMF.

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