RUPEE FALLS UNDER IMMENSE PRESSURE
DR. RIZWANA BASHIR
Aug 13 - 19, 2012
The rupee entered into a free-fall vs dollar making the life in Pakistan complicated. High demand of dollar in the local currency market and its strengthening value in the global market kept the rupee under pressure, which is speculated to touch Rs100 this year.
The blame of rupee devaluation is being laid on global conditions and the appreciation in the US dollar. But it is more of internal factors; like heavy reliance on imports, expenditures on debt servicing, county's poor economic condition and consumption-oriented fiscal strategies of government, all causing the demand for dollar to go up and rupee to fall free. A sharp appreciation of the rupee seems unlikely at the moment, for which the weakening domestic fundamentals are to blame. No attention was paid to enhancing the long-term growth of the economy. The natural consequence was a rise in fiscal deficit, a fall in domestic savings and a sharp rise in imports, including the effect of oil prices. This widened the current account deficit to unmanageable proportions.
The depreciation in currency increases inflation. The only benefit of inflation believed to be its positive impact on exports and fewer imports which complement getting the Balance of Payment improved. This benefit can not be taken in Pakistan economy because its fundamentals do not allow as Pakistan imports can yet not be substituted and export can also not be increased without increase in output. To curb inflation, State Bank of Pakistan keeps interest rate very high with an objective of tightening the economy. This increases the cost of capital and businesses do not expand due to high cost of borrowing.
Devaluation is usually undertaken as a means of correcting a deficit in the balance of payments. Some analyst are of the view that weakening the value of currency could actually be good for the economy - since a weaker currency will boost exports, which in turn will lift employment and all this will set in motion economic growth and keep the economy going.
Dollar jumps up to all-time high. Rupee depreciates further. Pakistan's cost of debt servicing also go up. Government's decision to print currency notes to finance its expenditure worsens the situation. Life of average Pakistani has become miserably tough to even survive with basics. Increased oil prices, electricity & gas charges and everyday food inflation are going beyond any limits. This situation has adversely influenced the society. It should not only be seen as an economic issue but a social issue as well. People are fighting a war of survival every day. I think it is the high time that politician's money from Swiss banks should be taken and brought back or it will be really late for us.
The problem for the rupee has become structural in nature. At the heart of the rupee's weakness is the issue of funding. With the capital flow restrained by a poor fundamental outlook, lack of policy decisions and debt redemption risks, this is likely to extend Pakistan's balance of payment deficit beyond in a couple of years.
Lower economic growth rate provides a weak base for rupee if dollar appreciates in international market. SBP has relaxed the policy rate and brought down to 10.5 percent after a long time to stimulate the stagnant economy. Policy decisions to expand economy can make long term economic growth possible and sustainable. If rupee has to confront with dollar appreciating in international market, this is the only possibility to make rupee stop falling free. A strong economy will sustain better.
As inflows from international financial institutions almost dried up, purchases from open market enabled the country to meet its payment obligations. Much of the reserve is eroded by increased oil prices in international market. Since June 2000, rupee has been put on free float and there has been depreciation of almost 12% with greater volatility and fluctuations. In addition reserves are also paid on external debt servicing in addition to rescheduling of debt. Efficient import substitution of furnace oil by domestically produced natural gas in thermal power generation and enhanced refinery capacity will lower the import bill for the petroleum products and improve the current account deficit. Thus new investment in gas exploration, transmission pipeline and distribution systems will have a large pay off both to the Pakistan economy as well as the investors. The government has therefore identified oil and gas as one of the four priority sectors for economical revival strategy.
Foreign Direct Investment is preferred to debt creating flows as it not only brings capital but also technology, employment generation and managerial skills. Multinational Corporations help promote competition in the sector by their improved corporate governance standards and practices which have to be emulated by the domestic companies to stay afloat. If MNCs flourish and earn profits from Pakistan even then Profits, Dividends and Remittances account for only a small fraction of our external payments. At least much smaller as compare to account of external debt servicing obligations. If FDI flows to Pakistan are doubled and payments on account of dividends, profits etc., rise in the same proportion we will have no difficulty in servicing them.
Under this scenario, the FDI inflows will lead to a diminution in external borrowing and hence our debt servicing would consequently decline. The investors will get a remunerative return on their investment which they can remit abroad without much difficulty while the country is able to reduce its dependence on foreign loans and the conditionalities associated with them in the form of drone attacks, intelligence sharing and other unacceptable demands. In fact, foreign investors will remit only if they are able to generate positive earnings for the economy unlike the external creditors who have to be paid fixed charges irrespective of the fact whether their loan has created positive cash flow or not.
Pakistan has suffered in the past due to perception of poor governance and reneging of contracts. This government is required to take actions to introduce transparency, predictability, rule of law and accountability in the system. Instead there is trust deficit found for government by international donors/investors. In the light of government's privatization policy foreign investors will have a great opportunity to own these assets, make them operationally and financially efficient and earn profits. Actions to provide safe and secure investment opportunities to foreign investors can build up their confidence to invest in Pakistan.
Pakistan government needs to take action to strengthen the balance of payments situation in the future. This should provide comfort to the potential investors about the security, return and transferability of their investment etc. A strong economy growing at a sustainable rate, control over non development consumption expenditures, investment not debt and import substitution are the best policies to safeguard rupee falling against dollar as well as to dilute its impacts on economy.
(The writer is Assistant Professor, Bahria University Karachi)