Rupee devaluation: a closer look

By keeping the rupee to dollar parity at an artificially higher level, Pakistan will suffer

On the 5^th of July, the value of the rupee suddenly took an unexpected plunge against the dollar as it lost more than 3 per cent of its value in one day. On that day, the dollar was trading at Rs108 in the exchange market. This depreciation sent the finance minister and his team scurrying to halt the slide. An inquiry was ordered as the finance minister asserted that the drop-in value was ‘artificial’. The rupee is now again trading at Rs105 against the dollar, but the fallout of the depreciation has been substantial.

The events of the 5^th of July might have been ‘unexpected’ for the finance minister and his team, but there is little doubt that a correction in the exchange rate was warranted since some time. Economists and experts, including those at institutions like International Monetary Fund, have little doubt that the rupee to dollar parity had been kept at an artificially high rate since long, and correction was needed in lieu of the market fundamentals. Pakistan’s ever widening current account deficit, for example, warranted a drop in the value of the rupee against the dollar. Besides, there is also a strong belief that by artificially keeping the value of rupee higher against the dollar, Pakistan’s exports to other countries deteriorated further as their level of competitiveness suffered. In essence, experts have been calling for a re-adjustment in the value of rupee in accordance with the demand and supply fundamentals and market forces.

On the 5^th of July, the State Bank of Pakistan did not intervene in order to allow exchange rate alignment as per the market fundamentals. This went against the policy of the government, especially the FM, who is known to be a strong opponent of devaluation of the rupee. It becomes easier for the FM to stick to his stance as the State Bank of Pakistan’s autonomy has considerably eroded in recent years due to appointment of hand-picked heads of State Bank of Pakistan by the Finance division. Those heads, in turn, have ensured that the prevalent exchange rate is as per the guidelines of the Finance division. However, the acting governor did not follow the norm and allowed the much-needed and much-anticipated adjustment. The State Bank of Pakistan’s statement said:

“….this depreciation (of by 3.1pc in a single day) in the exchange rate will address the emerging imbalance in the external account and strengthen the growth prospects of the country... the current exchange rate (of Rs108.25 to the dollar) is broadly aligned with the economic fundamentals.”

Not surprisingly, this stance did not go down well with the finance minister. Within days, a new governor of the State Bank of Pakistan was appointed in the form of Tariq Bajwa, a recently retired bureaucrat who is also thought to be a close confidant of the finance minister. His appointment confirms the perception that the finance minister and the finance division want to run the State Bank of Pakistan as per their wishes rather than granting it complete autonomy to pursue its work independently. This does not augur well for institutional independence as well as Pakistan’s economy.

By keeping the rupee to dollar parity at an artificially higher level, Pakistan’s declining exports are set to suffer further.

Published in The Express Tribune, July 17^th, 2017.

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