By Kazim Alam
The State Bank of Pakistan just allowed the rupee to devalue against the dollar by 3.1 per cent to Rs108.095. That’s the biggest plunge in the rupee’s value in nine years, according to Bloomberg News.
Here’s a piece I wrote a couple of months back on the topic of devaluation. Your feedback is welcome.
WATCHERS OF THE exchange rate are divided in two distinct camps.
The first camp consists, in large part, of simpletons who believe a strong currency is good for Pakistan. For them, a strong rupee is a hallmark of a strong economy. Consequently, they believe their own ability to buy more dollars using fewer rupees is the best barometer of national economic strength.
The other camp believes that depreciating the rupee bodes well for the economy because it helps grow the country’s exports. This camp knows a thing or two about economics, as its recipe to increase exports is well-founded in modern economic theory. After all, nearly all economic turnarounds in the recent decades were shaped by export-oriented policies of once-struggling economies.
It is in this context that I found a recent op-ed in The Express Tribune quite interesting. “Misinterpretations regarding exchange rates” by Dr Sajid Amin Javed, a research fellow at the Sustainable Development Policy Institute, neatly lays out the pros and cons of depreciating a national currency.
The article presents both sides of the picture, but the underlying assumption is clear: depreciation increases exports. Of course, the writer duly brings up (negative) side effects of depreciating the currency to increase exports. But he remains unambiguous about the inverse relationship between depreciation and exports throughout the article.
“Depreciation may sound unwanted in the short run, but it benefits the country in the long run. It increases exports, decreases imports and thus reduces trade deficit,” Javed says.
I have two objections to his overall argument. The first objection is logical. The second one is logical as well as moral.
1) Growth in exports is not an automatic outcome of currency devaluation
2) Currency devaluation rigs the system in your favour. It’s a bad business practice and immoral
Let me describe each of the two arguments below.
1) Currency devaluation is not a magic wand that delivers actual growth in exports
a) The value of the local currency against the dollar is not the sole determinant of the level of exports. If that was the case, Zimbabwe and Venezuela would be the largest exporters worldwide. It’s plainly obvious, yet noteworthy that a host of factors contribute to a country’s export competitiveness. It is painful to see how commentators hand out a quick fix to the low-export problem in the shape of a weaker rupee.
Look at the latest Ease of Doing Business Index released by the World Bank that ranks Pakistan 144th out of 189 economies of the world. Pakistan’s exports would remain paltry even if a dollar was worth Rs1,000 as long as it continued to hold its current 172nd position on the indicator of trading across the border. Yes, you read it right. Pakistan is among the bottom 20 of the 189 economies of the world when it comes to trading across the border. I don’t know how depreciating the rupee can help grow exports in such a business environment.
b) The rupee has been losing its value against the dollar since forever. Its relative ‘strength’ against the greenback dates back to the arrival of Ishaq Dar at the Ministry of Finance and coincides with the build-up of foreign exchange reserves from $3.2 billion to $24.5 billion.
Depreciating the rupee has not helped Pakistan grow exports. Just look at the chart below prepared by American economists Atif Mian and Amir Sufi that compares export per capita of Pakistan and India since the early 1980s. You don’t even have to pull up the data on the rupee’s depreciation all these years in case you’re in your 30s: our parents always preferred keeping savings in either gold or dollars to hedge against the devaluation of the rupee. But did that devaluation result in the rise of our exports? The following graph is yelling ‘no’ to me.
c) The Tribune article notes that rising exports generate income and employment opportunities. Yes, sure. But producing goods and services for the domestic consumption also increases incomes and creates jobs. After all, the economy as measured by gross domestic product (GDP) consists of four things: consumption, government expenditure, investments and net exports. Net exports that currently hover around $22 billion constitute only about 8% of Pakistan’s GDP.
Pakistan’s economy is consumption-oriented with a high marginal propensity to consume i.e. personal spending goes up in conjunction with the rise in income. According to official government statistics, the private consumption expenditure in nominal terms was over 80% of GDP in 2015-16.
Rising exports will increase the income of the people engaged in producing exportable goods. Similarly, people producing goods for domestic consumption will benefit more if the government adopts the policy of strengthening the purchasing power of the local consumer – a direct outcome of a stable exchange rate. It’s up to policymakers to assess how to ensure the maximum economic benefit for the maximum number of people.
2) Currency devaluation is immoral
The devaluation in currency means changing its value in the international marketplace to make the system work in your favour. It does two things. One, it erodes the purchasing power of your fellow citizens (that’s a no-brainer).
Two, it rigs the system temporarily in your favour. It’s the rigging of a very basic kind if you think about it. It gives you the false pretence of winning for a short term while you cause a long-term damage to the system by signalling to your competitor that it’s OK to change rules in the middle of the game.
It’s like tinkering with the meter of the cab you’re driving. You drive 900 metres but the system tells you that the cab travelled one kilometre. It’s like bowling from a distance of 21 yards instead of 22 yards in order to make your yorker faster.
Remember, the exchange rate is just a number. It means nothing on its own. In essence, the exchange rate tells you how much one currency is worth against another. Rigging its value at whim erodes the trust people have in it. Imagine if every country appointed overzealous bureaucrats to make exchange rates favourable to their trade balance. There’ll be havoc as international trade will collapse.
The exchange rate should ideally be stable and reflective of economic fundamentals, not the whims of national treasury managers.