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Devaluation and its impact

Only logical path is to reduce cost of production

By Abdul Rahman Batada
Mar 05 - 11, 2001

Devaluation of a currency was a matter of prestige in the past. However with the lapse of time it has been learnt that such an operation is sometime necessary to save the country from economic hardships.

Devaluation of a currency has become very common in the present age. Countries facing financial strains due to unfavourable economic conditions have no alternative but to devalue its currency so as to push up its exports earnings and simultaneously to decrease imports. Such countries usually officially decrease the value of their currency in relation to gold as well as other foreign currencies

General factors leading to devaluation: Persistent adverse trade balance and disequilibrium in balance of payment are the main causes, which compels a country to devalue its currency. Major components of trade balance are exports and imports of a country. Adverse trade balance is generally the result of slackness in exports in comparison to imports.

Exports: Developing countries who in general export primary goods encounter adverse balance of trade frequently. The reasons for lagging behind their exports is this that they export primary goods, which faces severe competition in the international market. It is interesting to note that competition in the world market takes place among developing countries only as they all produce primary goods and export them. Simply it can be easily deduced from the standing facts that when a country's exports remain stagnant and does not rise even after taking necessary steps for its promotion and whose imports continue to rise dislocating the balance of payment position and widening the current account deficit are left with only one alternative viz.devaluation of its currency to ease the situation. Such developing countries are in acute shortage of foreign exchange reserves, which are needed for capital formation in the country. Devaluation is nothing but an official decrease of value of a currency in relation to gold and other currencies indicating a desperate attempt made by the government to promote and boost its exports, in the world market.

Imports: Oil, mineral fuels, lubricant, chemicals, manufactured goods, machinery and spares and food items consists of import of developing countries. These import items are quite necessary for the very survival of the economy, as such it is very difficult to reduce them substantially. Hence such the imports of developing countries are usually on high side for obvious reasons. Since the process of capital formation remains in progress it is not possible for a country to decrease imports beyond limit as it may adversely affect the development plans undertaken by the Government. Government has only one option in hand to stop the imports of luxury items such as big cars Mercedes etc.

Pakistan's reference: Pakistan is also a developing economy. Some of the items of its exports are oil seed, cotton, rice, wool, fish fresh, chilled frozen, tobacco etc. Main export items are rice and Cotton. Pakistan also faces severe competition in the world market like other developing countries. The volume of exportable goods like cotton and rice also depend upon climate in the country, which determine good or bad harvest. It is agonizing to accept that even after good harvest due to favourable climate Pakistani goods can fetch better prices only if the harvest in competing nations has been bad due to unfavourable climate. Pakistan has made consistent efforts to increase and diversify its exports but no cogent results have so far been achieved. Very recently Pakistan has been paying acute attention in the sector of Information Technology. Every endeavour is being made to enrich the younger generation of the country towards this sector so as to boost software exports and promote email commerce. India our main rival is far ahead of Pakistan in this field. Since the government now give due recognition to the matter it is hoped that we will pick up momentum very soon.

Main items of imports in Pakistan are petroleum and petroleum products, vegetable oil and fats, tea, wheat, milk and cream etc. The import bill of the country despite best efforts could not be brought down. Import of petroleum and petroleum products is very vital for the survival of the economy. A substantial portion of our foreign exchange is also utilized for the import of tea. Moreover the prices of petroleum and its products prevailing in the international market have direct impact on Pakistan's trade balance and its balance of payment. Increase in prices of petroleum and petroleum products also results in corresponding increase in numerous items attached with it changing overall price structure in the country.

Pakistan's balance of trade position for the last few years is depicted from the following table.

BALANCE OF TRADE

Million US $

Period

Exports

Re-Exports

Imports

Re-Imports

Balance
of Trade

1992-93

6819.3

34.1

9963.2

1.8

(-)3111.6

1993-94

6812.8

26.9

8561.6

3.9

(-)1725.8

1994-95

8137.2

35.4

10394.5

3.1

(-)2224.4

1995-96

8707.1

38.7

11804.9

4.4

(-)3063.5

1996-97

8320.3

75.6

11894.2

16.1

(-)3514.4

1997-98

8627.7

76.3

10118.0

4.6

(-)1418.6

1998-99

7779.3

70.1

9431.7

14.2

(-)1596.5

(Source SBP Annual Report 1998-1999)

It is evident that country's balance of trade was unfavourable throughout the period.

Pakistan has time and again devalued its currency anticipating that it will boost its exports and will make the exportable goods of the country more competitive in the world market. But these wishes have failed to materialize so far. Our goods failed to compete with our neighbouring countries despite the fact that their currencies were stronger than ours. It is strange to see that despite using the same factors of production and also devaluing our currency, our goods fail to compete with other goods. This is so because our domestic input cost of production is quite higher than our neighbouring countries.

Conclusions: Devaluation decreases the prices of our exportable goods and simultaneously increases prices of goods we are importing from abroad as well as increases domestic price level of goods and commodities, thus reducing the purchasing power of the people of the country. It may create inflation in the country. Our long experience has shown us that devaluation is not the proper remedy for economic growth of the country. It has resulted in increasing our debt burden to the extent that nowadays it is not possible to obtain easily any aid from world lending agencies. It may be realized that for whatever reason we devalue our currency it results in manifestation of weakness of our economy to the other countries. Further, excessive devaluation of the past has adversely affected our credit rating. Moreover foreign investors are now more conscious or reluctant for making any investment in the country. Only logical path available to us is to try to reduce the cost of production of our exportable goods and increase the productivity of the goods, which will enable us to compete in the world market. Participation of everyone concerned towards the above goal will make a difference, but we should do it now not later.