HOW WEAK CURRENCY ERODES PURCHASE POWER AND ADDS TO INFLATION

ATIF HASSAN
(feedback@pgeconomist.com)

Aug 13 - 19, 20
12

Devaluation occurs when National currency of Pakistan becomes weaker in terms of either gold or other international currencies. Devaluation of currency is a major factor posing threat to Pakistan's economy. Starting from 1955 till today, Pakistan has experienced constant problem of currency devaluation. Its impact is evident on all other major sectors of economy as well. Devaluation is responsible for causing following impact on Pakistan's economy.

One of the most important factors influencing poverty in the country is inflation. Inflation is defined as a situation where general price level is persistently moving upward in a country. In Pakistan the general price level is persistently rising since its establishment. The prices remained volatile during the decade of 1990's ranging from 5.7 % to 13 % mainly because of declining economic growth, expansionary prices, output setbacks, higher taxes and a depreciation of Pakistan rupee.

There are many causes for inflation, depending on a number of factors. For example, inflation can happen when governments print an excess of money to deal with a crisis. When any extra money is created, it will increase some societal group's buying power. As a result, prices end up rising at an extremely high speed to keep up with the currency surplus. All sectors in the economy try to buy more than the economy can produce. Shortages are then created and merchants lose business. To compensate, some merchants raise their prices. Others don't offer discounts or sales. In the end, the price level rises. This is called demand-pull inflation, in which prices are forced upwards because of a high demand, and excessive monetary growth. For inflation to continue, the money supply must grow faster than the real GDP.

Another common reason of inflation is a rise in production costs, which leads to an increase in the price of the final product. For example, if raw materials increase in price, this leads to the cost of production increasing, this in turn leads to the company increasing prices to maintain their profits, this kind of inflation is call cost-push inflation. Furthermore, rising labour costs can also lead to inflation, because workers demand wage increases, and companies usually chose to pass on those costs to their customers, this sort of inflation is called wage-push inflation.

Inflation can also be caused by international lending and national debts. As nations borrow money, they have to deal with interests, which in the end cause prices to rise as a way of keeping up with their debts. A deep drop of the exchange rate can also result in inflation, as governments will have to deal with differences in the import/export level.

The most immediate effects of inflation are the decreased purchasing power of the rupee and its depreciation. Depreciation is especially hard on retired people with fixed incomes, as spending power decreases each month. Those not on fixed incomes are more able to cope, because they can simply increase their income. Another destabilizing effect of inflation is that some people choose to speculate heavily in an attempt to take advantage of the higher price level. Because some of the purchases are high-risk investments, spending is diverted from the normal channels and some structural unemployment may take place. Finally, inflation alters the distribution of income. Lenders are generally hurt more than borrowers during long inflationary periods, which mean that loans made earlier are repaid later in inflated rupees. Inflation weakens the function of money as storage of value, because each unit of money is worth less with the passing of time. The progressive loss of the value of money during a period of inflation makes the borrowers to be less willing to use the money as standard differed payments.

Almost over 30 percent depreciation of Pakistan rupee against US dollar since the beginning of 2008 has nearly halted economic growth in the country, hitting all the important areas of economy from agriculture to industry; manufacturing to import of goods; IT sector to students studying abroad and government should take immediate measures to arrest further devaluation of rupee to avoid more damaging consequences for the economy.

Our economy is in slump as all sectors of economy are showing negative growth and warned that further fall in value of rupee will cause more contraction in economic activity leading to reduced tax revenue for government and huge foreign debt, the decline in the exchange rate goes on in spite of the fact that foreign exchange reserves have almost doubled, which should be a cause of great concern for policy makers.

The key reason for the rising prices in the country is cost-pushed inflation, mainly due to rising commodity prices and depreciating Rupee. He said unfortunately both the factors do not bode well at present as commodity prices are on the rise and value of rupee on the fall. While the economic implications of the depreciating Rupee are extensive with inflation being a key concern, equities market not only provides a hedge but also offer opportunities in terms of active gains.

Exporters of textiles and clothing are likely to benefit the most from depreciating Rupee as well as all those companies where pricing mechanism is linked with Dollar and international prices. Possible losers would include importers of materials/inputs while their tendency to pass-on impact to end consumer would ultimately govern earnings impact. He said companies in the business of producing oil would benefit from Rupee depreciation since pricing is regulated and crude is ultimately priced in Dollars.

Devaluation with its implications will cause a contraction in economic activity and consequential slide down in income tax receipts will raise the burden of Pakistan's defence equipment, and foreign debt overnight. It cannot stop smuggling as long as black- market transactions in foreign exchange continue. Devaluing the Pak. Rupee means devaluing the price of Pak labour and talent in the international market who send foreign exchange through home remittance. Devaluation will make Pakistan lose heavily both as seller and as a buyer and will make no good substitute for remedial changes in economic policies and developmental planning. Devaluation of Pakistan Rupee will mean devaluation of Pakistan labour and talent in the international market evaluation will serve as a drug rather as a stimulant and cause an unprecedented inflation.

Bold steps must be taken to enliven capital market and more foreign aid procured. Strong disciplined should exercised over all unproductive expenditure, whether it be public sector or private sector. Lavish spending of aid was bad enough, but it would be even worse to raise the cost of debt repayment through devaluation, whose benefits in terms of larger foreign investment are quite illusory.