DEVALUATION OF PAK RUPEE
PROF. SAEED AHMAD SIDDIQUI
Feb 20 - 26, 2012
Devaluation refers to decrease in the value (purchasing power) of local currency in terms of gold or the currency of foreign country/countries. Terms 'depreciation' and 'devaluation' are taken as alternate of one another but they differ in technical sense. Value of currency is determined by demand for and supply of money. The term 'devaluation' is particularly used when a country officially announces decrease in the value of its currency under fixed exchange rate system. Contrary to it, the term 'depreciation' means decrease in the value of local currency unofficially under free floating exchange system.
Devaluation policy is generally adopted by a country for correcting the balance of payments. Some of the economic experts and analysts opine that weakness of local currency is advantageous for the economy because weak currency boosts exports due to which employment increases and it guarantees growth and development of the economy.
In accordance with the history of devaluation in Pakistan, first time it was exercised in 1955 due to which wholesale prices increased and since the production structure was inelastic therefore, inflationary pressure became uncontrollable. Second time, Pak rupee was announced to be devalued by 56.7 percent on May 11, 1972. In other words, rate of exchange between Pak rupee and US dollar before 1972 was Rs4.44 a dollar which increased to Rs11 a dollar after 1972.
On January 8, 1982, fixed official rate of exchange was abolished delinking Pak rupee with US dollar and joining basket of currencies. Consequently, Pak rupee was devalued further. After 1982, Pak rupee has been depreciating constantly. It should be noted that devaluation might be beneficial only with reference to the goods demand of which is price inelastic in foreign market. In other words, devaluation may be beneficial temporarily not permanent. Devaluation is real danger for real estate of Pakistan.
Causes: There are various causes of currency crisis in Pakistan including political, economic and corruption. But, for comprehending the basic reasons of currency crisis, we are required to focus on important economic variables which are interconnected and referred as under:
1. FISCAL DEFICIT: The government, to bridge the negative gap between government income and expenditure, borrows continuously from SBP and external sources. When SBP lends to the government, new money is injected into the economy, which increases rate of inflation. Hyperinflation curtails exports. Inflation, increasing the cost of export goods, makes prices less competitive.
2. PRICE SHOCKS: Price shocks is also one of the causes of devaluation of Pak rupee which means fall in price of export goods and rise in import goods. The cause of devaluation in Pak currency that is discussed frequently is persistent increase in the price of imported crude oil. The price of crude oil on May 15 was $127 a barrel which increased to $128 per barrel next day.
3. EXPANSIONARY FISCAL OR MONETARY POLICY: The previous government, for expediting the pace of economic development of the economy, adopted expansionary fiscal and monetary policies, which increased aggregate demand in the country while supply could not keep its pace with demand. For filling the negative gap between aggregate demand and available supply, refuge was sought out in imports.
Current account deficit is being increased constantly. To finance this deficit, either foreign exchange reserves or capital inflow may be used but capital inflow, in the light of financial position of the country, is not possible because foreign investors have lost confidence in the economy.
4. FAULTY FINANCIAL SYSTEM: Defects of financial system plays crucial role in the development of a country but in case of Pakistan, capital inflow is volatile. Capital inflow converts soon in massive outflow because countries like Pakistan where non-transparent and defective financial system prevails are bound to face currency crisis. After 9/11, incoming home remittance promoted equity unduly. Consequently, situation became worst due to overinvestment in real estate. The fact is that financial system and the economic organizers failed to use massive capital inflow constructively.
5. SPECULATIVE PRESSURE: In an emerging economy like Pakistan, speculation has always been behind abnormal and exception behavior. The speculation factor has mounted the issue in Pakistan through creating shortage of US dollar in local Kerb Market. Some banks indiscriminately engaged in expediting trading activities due to which unnecessary panic was created and these banks encouraged their exporting clients for receiving their remittance late. Consequently, liquid foreign exchange reserves decreased further.
6. REAL FOREIGN EXCHANGE RATE: Real rate of foreign exchange refers to the relative price of equal basket of goods between the two countries. Appreciation in real exchange rate creates pressure of currency devaluation because it hurts all the firms that are foreign competitors. Increase in real rate of exchange curtails exports because their cost of production is measured in foreign currency. The firms that are involved in import competition also lose because the foreign competitors do not feel any pressure to increase their export prices with inflation in the importing country.
7. LOW FOREIGN DIRECT & PORTFOLIO INVESTMENT AND CAPITAL FLIGHT: It is also one of the factors behind rupee crisis. Under the impact of present political, economic and uncertain environment in Pakistan, investors are engaged in withdrawing their capital from the country. The capital flight is the cause of decrease in SCRA (Special Convertible Rupee Account). foreign direct investment and portfolio investments are decreasing consistently.
Pak Rupee Vs Other Currencies: If value of Pak rupee in February 2011 is compared with the currencies of 20 important countries of the world in February 2012, it is revealed that value of Pak currency is constantly depreciating which is highly alarming in different aspects.
The scope of economic crisis through devaluation of Pak rupee can be evaluated with the fact that Pak rupee has not only been devalued against Indian rupee but also against Nepal and Bangladesh. Persistent depreciation in the value of Pak rupee is also creating alarming imbalance between exports to and imports from Pakistan. During the last decade (2000-10), value of Pak rupee against 20 strong currencies has been devalued from 12 to 135 per cent.
According to statistical information provided by SBP, value of US$ in 2000-01 was Rs58.4 which jumped to RsRs.90.55 in 2012, British pound increased from Rs84.7 to Rs143.9, the Euro from Rs55 to Rs134.06, Australian dollar from Rs31.2 to Rs97.77, and Chinese Yuan from Rs7 to 12.2. It should be noted that the value of Japanese Yen and currency of Nepal were lower in value against Pak rupee but both increased from Rs0.51 to Rs1.20036 and from Rs0.78 to Rs1.11 respectively. Indian rupee increased from Rs1.25 to Rs1.80 and taka of Bangladesh from Rs1 to Rs1.25.
By comparing Pak currency with currencies of the Muslim World, it is revealed that Kuwaiti dinar increased from Rs190.4 to Rs381.86, Saudi Riyal from Rs15.5 to Rs24.12 while UAE dirham from Rs15.9 to Rs24.78
Currencies with which the value of Pak rupee has been depreciated include franc of Switzerland, Krone of Norway and Swedish Krone, Bhat of Thailand, dollar of Singapore, Ringgit of Malaysia and dollar of Hong Kong.
IMPACT OF DEVALUATION ON THE ECONOMY: The possible affects of devaluation of local currency can be referred as under:
1. Terms of trade are improved due to stimulation in merchandise exports and discouraging merchandise imports.
2. Increase in revenue collection and savings in repatriation of profits and royalties by existing foreign investors.
3. End of gold smuggling by bringing illegal leakage of foreign exchange in official channel.
4. Inflow of foreign capital provided no price increase takes place.
5. Use of full production capacity of industrial sector becomes possible through control on imports.
6. Boost in exports makes monopoly profits reserved for few exporters.
7. Inefficient market regulation and budget increase enormous pressure on domestic prices.
8. Effect of devaluation in the short period makes balance of payments unfavorable and consequently burden of foreign loans and debt services increases due to which repayment of foreign loans disturbs the budget-creating trade gap.
9. Cost-price relationship in the economy is disturbed.
10. Galloping inflation is created.
11. Rapid increase in costs makes various ongoing projects stall.
If consequences and intensity of Pak rupee devaluation is analyzed, it can't be declared more serious and severe more than Peso crisis of Mexico in 1994 or currency crisis of South East countries in 1997 and Ruble crisis in 1998. Some experts firmly believe that Pak rupee crisis is a speculative pressure, which can't be continued for a long period. Value of Pak rupee should be stabilized due to upcoming major influx of US dollars in local market stabilizing the rate of exchange at Rs65 or 66 a dollar.