FREEFALL OF PAK RUPEE AGAINST US DOLLAR

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)
Mar 8 - 14, 2010

Freefall of Pakistani rupee against US dollar has increased inflation and the country's external debt. The frequent depreciation of the exchange rate in two years added Rs1125 billion to public debt, significantly increasing the rupee cost of foreign debt servicing. The total foreign and domestic public debt is at 58.1 per cent of the GDP, according to Debt Policy Statement 2009-2010. The consistent depreciation of the local currency against green bank is also contributing factor to inflationary pressures. The depreciating rupee has also failed to increase the country's exports, which have been stagnant for the last two years.

Soaring prices of essential commodities including foodstuff have made the lives of the poor and the lower middle class increasingly difficult, as they are struggling to meet the minimum standards of living. The recent round of rupee depreciation has been aggravated by black-marketing of the US dollar, which some businessmen are willing to buy even at a higher rate. The rupee, which hit a record low of 85.15 against the US dollar last month, has weakened 1.02 per cent this year after losing 6.17 per cent in 2009. It lost 22.12 per cent in 2008.

Depreciation of rupee is fuelling inflation and eroding the purchasing power of the people belonging to the middle class. Consumer price index (CPI) inflation escalated sharply to 13.7 per cent year-on-year in January on the back of rising oil and power prices after dipping to 10.5 percent the previous month. Sensitive Price Index (SPI) inflation for the week ending February 18 registered an increase of 16.82 percent as compared to the same period of previous year, according to the Federal Bureau of Statistics (FBS).

State Bank of Pakistan (SBP) kept interest rates high to attract documented savers' money to help meet government's expenditure needs. In its Monetary Policy Statement (MPS) for February and March, the central bank kept its key policy interest rate unchanged at 12.5 percent to sustain growth and keep inflation in check. The bank has identified prominent risks to the economy which include uncertainty on the availability of external financial inflows, rising international commodity prices and extent of impetus received from the global economic recovery. The central bank expects that the overall real GDP growth to be at 3 to 3.5 percent in the current fiscal year 2009-10 (July-June), as compared to 2 percent in the last fiscal.

The central bank recently announced that foreign exchange reserves of the country will reach $15 billion by end of the current fiscal year 2009-10. Higher foreign exchange reserves is a sign of strength for exchange rate but the local rupee is still depreciating against all major currencies on day-to-day basis.

The growth of per capita income also 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 per cent indicated a negative growth in per capita income in the last fiscal year 2008-09. The rupee dropped from Rs60 a dollar to Rs80 just in a few months in 2008-09.

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.85 to a dollar in the inter-bank market.

Rupee devaluation has raised the cost of doing business due to industries' heavy reliance on imported raw material. The industrialists and traders contend that unchanged discount rate would further increase the cost of production and destroy the industries, as it is already suffering from exorbitantly high business cost. The central bank cut its discount rate by 50 basis points to 12.5 percent in November after keeping it unchanged at 13 percent in September. The experts argue that industries in Pakistan are heavily dependent on imported raw materials for industrial goods and capital goods and components, and their access to many advanced countries are blocked by quotas and tariffs.

Black-marketing of the US dollar has not only depreciated the Pakistani rupee against the greenback but it has also widened difference in the exchange rate in the country's open and inter-bank markets. Last month, while the rupee crossed the Rs87 mark against the US dollar in the open market, it was traded at Rs85 for a dollar in the inter-bank market. The demand of the US dollar surged after the central bank made it mandatory for everyone to show personal ID for purchase or sale of greenback. Currency devaluation caused contraction in economic activities and promoted smuggling, as black-market transactions in foreign exchange continue. The smugglers gain more mileage after devaluation as the impact of government levies on imports increases due to the decline in rupee value. Critics say that the demand of dollar in the open market has surged due to the low vigilance on part of the government's investigative agencies, as addressing the problem of high parallel economy (black economy) is more of an administrative and enforcement issue than that of policy making.

The central bank had recently made it mandatory for everyone who buys or sells the US dollar from exchange companies to surrender copy of National Identity Card. The people are reluctant to sell the US currency to exchange companies because they do not want to disclose their identity.

Experts suggest that the domestic undocumented money needs to be channelized for fiscal spending and private sector project financing in order to reduce dependence on donors and to regain self reliance. Amid tight liquidity condition owing to a dearth of foreign inflows, the government is making efforts to spur domestic savings which have declined by 650 bps to mere 14.3 percent of gross domestic product (GDP) in the span of last six years. Increase in domestic savings will not only help the government plug in its deficit but will also provide much-needed liquidity to the private sector.