DEVALUATION OF RUPEE HAS CAUSED INFLATIONARY PRESSURES

SAAD ANWAR HASHMI 
(feedback@pgeconomist.com)

Aug 13 - 19, 20
12

Devaluation is reduction in the value of a currency with respect to goods, services or other monetary units with which the given currency can be exchanged. In Pakistan, the Rupee is always measured with USD since foreign trade and settlements are done in Dollars in most cases. SBP has adopted a Managed Float policy with the exchange rate where the Central Bank attempts to manage fluctuations and keep the exchange rate stable. Pakistan has witnessed consistent devaluation in exchange rate over time with USD currently trading between PKR 94.2 and PKR 95.0 expected to cross the parity of PKR 100 based on the current economic state. Devaluation or Appreciation in the currency is considered a natural process for any country where managing the fluctuation and variance in short period of times is paramount. Governments around the world, including Pakistan at times resort to devaluation as a tool to protect their trade balances.

With respect to Pakistan, the country has struggled to increase its export base relative to imports being a net importer. Pakistan has not made any significant efforts to promote import substitute industries which would help the country procure suppliers from within rather resort to heavy reliance on imports. According to the latest figures released by Pakistan Bureau of Statistics, imports were USD 44.912 Billion in FY12 as compared to USD 40.414 billion in FY11, an increase of 11.13 percent. On the contrary, exports reduced from USD 24.81 billion in FY11 to USD 23.64 billion in FY12, a decline of 4.71 percent increasing balance of trade from USD 15.60 billion in FY11 to USD 21.27 billion in FY12, an increase of 36.32 percent. SBP reserves as on August 2012 are USD 14.57 billion. Pakistan being a net import has put further pressure on reserves for import payments with the devaluation. There are many advantages and disadvantages of country devaluating the exchange rate therefore it is essential to analyze what a country like Pakistan can gain from such devaluations and what is the implication of devaluation on the economy.

The core advantage for Pakistan to devaluate the exchange rate is the effort to increase the export base. Devaluation results in domestic production being cheaper for foreign buyers thereby resulting in an increase in exports. Through this is what economics teaches us, the impact on Pakistan has been complete opposite where exports have actually reduced in FY12 compared to previous year. The country faces issues with respect to high costs associated with raw materials, power, electricity, gas, fuel including finance cost which has negated any advantage that devaluation would have brought by making domestic production expensive to foreign buyers in terms of price. On the contrary, increase in cost of manufacturing has resulted in an increase in the selling price making our exports uncompetitive. In addition, political unrest in the country and law and order issues further result in reduction and cancellation of export orders. The industry most affected with increase in costs and reduction in export orders has been the textile industry being the only fallback for Pakistan to be able to increase exports. As per theory, higher level of exports should lead to an improvement in the current account deficit. We have witnessed that the current account deficit has increased with imports double that of exports. Another assumption to devalue the currency is that increase in exports would help develop the industry leading to higher GDP. Based on a recent report published by World Bank titled "Country Partnership Strategy Progress Report FY2010-14", the way forward for Pakistan to increase GDP is to enhance its reliance on industrial growth to ensure long term sustainable development. The industrial growth should be geared through ease in availability of credit and confidence of both foreign and domestic investors to invest in development projects to create employment. Unfortunately, this methodology cannot be seen in isolation with impending law and order situation along with political uncertainly which shakes investor confidence to invest in export oriented industries. Manufacturing concerns are therefore on a status quo and are continuing with current capacity rather than seek capacity expansion. The consumer demand due to high inflation is highly skewed towards meeting monthly food requirements than expenditure on luxuries or necessities of that matter.

The disadvantage of devaluation for an import oriented economy of Pakistan is that imports become more expensive consequently increasing costs which have to be passed on to the consumers resulting in inflation. Though there is pressure on rupee through devaluation, the GDP is expected to grow and remain between 2.8% and 3.2% through FY13 which again is being seen as a cause for inflation creating a demand and supply gap. With respect to inflation driven through the demand side, Pakistan with a population of 180 million people is a natural component for inflation with a need to constantly increase food supplies for the masses. Devaluation in Pakistan has been a catalyst for inflation which has remained in double digits and not expected to decrease to single digits through FY13 keeping with devaluation of currency along with high cost of inputs. The core cause of concern for SBP is government borrowing has yet to be reduced. If oil prices decrease, any such decrease will be negated through the devaluation of rupee against the dollar and likely to increase the import bill causing inflation. CPI was recorded at 12.4% as on July 2012. Devaluation of the exchange rate can only benefit Pakistan if inflation is manageable and reduced where export oriented industries are provided incentives giving cushion in costs to make exports competitive. Imports are required to be reduced through setting up industries which can manufacture products as a substitute to imports. The value of PKR against the Dollar may only show improvement if reserves remain healthy and that exports exceed imports through tight cost controls over utilities resulting in inflationary pressures.