Dar and the rupee

Finance Minister Ishaq Dar swore to bring the dollar down to less than Rs100. Lo and behold! This exactly is the situation. However, the rupee’s appreciation may have a psychological and political significance, but none in terms of prudent economic policy. The numerical value of the exchange rate matters, but what matters more is its persistence over time. Exchange rate stability and predictability are crucial for investment decisions and forward contracts. Firm business decisions are based on anticipated and not unanticipated developments. In the present case, the linchpin of the whole exercise is the sudden emergence of the $1.5 billion Pakistan Development Fund, resonant of the No Questions Asked schemes floated for overseas Pakistanis in the second coming of the PML-N government. Our perennial dependence on external inflows creates a monetary situation, whereby the short run exchange rate is critically dependent on these inflows exceeding outflows. As the inflows, i.e., the so-called bilateral and multilateral concessional assistance, depend on political and strategic, rather than economic considerations, any disruption quickly eats into foreign exchange reserves, which translates into pressure on the rupee. This has been the case since the termination of the IMF programme under the PPP government. The present government’s agreement with the IMF failed to stop the net outflow. It did, however, create space for Mr Dar to look elsewhere for boosting the inflows. There is no perceptible change in the weak fundamentals of the economy. The fiscal and current account deficits continue to be problematic and inflation remains high. There is no jump in remittances, or in foreign investment.

Unanticipated inflows resulting from Mr Dar’s secret hard work may well cause what economists know as the Dutch disease. A sudden increase in foreign inflows leading to currency appreciation hurts the manufacturing sector and exports. In our case, the margin of preference expected from the GSP-Plus status is likely to be neutralised by an ever-strengthening rupee. Exports are the basis of real, sustained inflows, not financial gamesmanship. Cheaper imports should benefit the consumer, but prices are notoriously sticky when they are supposed to fall. Yields from customs duties and sales tax on imports are likely to fall, adding to the fiscal woes of the government. The external debt burden and its servicing cost will come down, but the larger fiscal burden originates from domestic debt. Even remittances may slow down.

The end justified the means. Speculators, invoice manipulators, exporters, importers and investors have been threatened with dire consequences, allowed or promised favourable SROs and even given seats at the budget-making table. Pseudo-economists, blamed for an unsympathetic narrative, have been accommodated as the Punjab chief minister’s advisers, or co-opted into the Economic Advisory Council and the Taxation Advisory Committee. Some have made an entry into think tanks set up by PML-N leaders.

A stronger rupee brings political acclaim, but the balance of economic gains is uncertain. Much depends on how long the fruits of Mr Dar’s labour last. In bringing the dollar down, he has proved his capacity to achieve objectives. If only he were to deploy the same energy on fixing the tax structure, the economy would have the inherent strength to weather any storm, including the currency crisis. The concessions given for a stronger rupee, along with revenue implications of appreciation, do not make the task of preparing the next budget any easier.

Published in The Express Tribune, March 14^th, 2014.

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