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The exchange rate is a crucial component of trade and a dynamic macroeconomic determinant. The trade balance is impacted by exchange rate fluctuations. The growth process is slowed down as a result of unstable exchange rates since they have an impact on capital flows, slow down commerce, and undermine investor confidence. The evaluation of investment operations, hedging, and financing, as well as the reduction of operational risks, are all aided by a stable exchange rate for financial institutions and businesses.

The evolving economic dynamics have changed the world economy and caused numerous difficulties in recent years. This includes rising food prices, inflation, and oil prices. Like many developing countries, Pakistan has also faced backlash because of the international changes as well as national developments such as political instability. Galati and Ho (2003) assert that changes in the news have a significant impact on currency rates. They investigated the idea that any good or positive news raises the value of a currency, but bad news causes it to decline. This has been recently witnessed in terms of the ever developing political instability in Pakistan.

The exchange rate has a two-way relationship with the exports and imports inter alia. The relationship works both ways whereby the fluctuating rate affects the exports and imports, similarly the fluctuating imports and exports affect the exchange rate. In addition to exports and imports, there are other macroeconomic factors that influence the exchange rate. These include interest rates, the current account balance, and the national debt.

The central bank controls the interest rates in an attempt to manage the exchange rates. Foreign investors prefer investing in countries with high interest rates because they can earn greater returns than in other nations. If the interest rate is higher, foreign capital will be drawn in, which will raise the exchange rate. If a country’s current account is in the red, foreign capital is borrowed to close the gap. Local currency loses value due to excessive foreign currency demand.

Moreover, the interest rate in Pakistan was increased by 125 basis points to 15% in July 2022 - following a 13-year peak in inflation, the rate was raised from 13.75 percent. Consequently, this is causing detrimental effects on the fuel cost as well as the inflation. Despite having a high interest rate (15%) in Pakistan, exchange rate devaluation isn’t in control; although the detrimental effects of high interest rate are quite visible in the form of lower investments, absence of progression in almost all industries among others. This calls for a spontaneous, long-term strategic action from the government side at large to bring back the economy on track by lowering the interest rate.

Pakistan has been under the grip of debilitating exchange rate for quite a time now. In the midst of escalating political unrest and economic difficulties, Pakistan’s currency hit a new low against the US dollar, shattering all previous records. The interbank closing rate of one dollar on 1st August 2022 was 238.84 Pakistani rupees.

Pakistan’s current account deficit (CAD) increased significantly during the course of 11 months (July to May) in 2021/2022, according to the State Bank of Pakistan (SBP). According to data from the balance of payments (BoP), the current account deficit in the equivalent months of the previous fiscal year was $1.18 billion. The enormous trade imbalance caused by the sharp rise in import costs may be to blame for the current account deficit’s massive growth. According to figures issued by the Pakistan Bureau of Statistics, the country’s trade deficit jumped by 58.18% to $43.42 billion between July and May 2021/2022 compared to $27.45 billion during the same period of the previous fiscal year (PBS).

Comparing the first 11 months of the current fiscal year to the same months of the previous fiscal year, the country’s import bill increased by 44.51 percent to $72.29 billion. However, export revenues also increased by 28% to $28.87 billion during the reviewed period from $22.57 billion during the same time of the previous fiscal year.

The increase in export revenue is primarily because of the performance of the textile sector in Pakistan. With exports rising from $12.5 billion just two years ago to nearly $20 billion now, the textile industry has set a new record. The implementation of the Regionally Competitive Energy Tariff (RCET), investments totaling more than $5 billion in development, and the establishment of 100 new textile facilities, which resulted in an increased export capacity of $500 million per month, all contributed to this tremendous boom. This doesn’t stop here, the sector has a potential to deliver $2 billion/month worth of exports, if provided with conducive environment.

In the upcoming fiscal year, textile exports are anticipated to reach $25 billion or more subject to energy availability at competitive rates. However, Pakistan will be obliged to look for additional $6 billion in loans from overseas, which under the current economic conditions would not even be doable, if this export momentum is lost owing to problems with energy supplies, cost restraints, and a crippling exchange rate.

In the longer run, the large devaluation of the rupee is worse for exporters especially textile exporters because it raises input costs, making exports less competitive. One of the biggest difficulties the sector faces is finding a steady supply of high-quality raw materials at reasonable rates.

Additionally, circumstances have developed that have caused Pakistan’s textile sector’s inputs, just like all of its other exporting sectors’ inputs to be measured in dollars in order to reduce the risks associated with currency volatility and to create a stable and secure environment for business. This includes raw materials, energy, dyes and chemicals, machinery, and spare parts, inter alia.

Simply said, a country’s exports become less expensive and its imports become more expensive as its currency depreciates. However, in a globalized economy, industries are vertically linked, and exported goods often contain a significant amount of imported components. Therefore, imported inputs become more expensive for any given exporter and are not always interchangeable with domestically produced goods.

Aftab and Abbas (2012) concluded that exchange rate instability has significant negative relationship with sectoral export of Pakistan except waxes and animal oils, aircraft, transport equipment and arms. A negative indication indicates that a rise in relative price is to blame for the decline in export demand. Their study also implied that the textile and textile articles showed a negative sign. Arize et al. (2003) also concluded in his study that in both the short- and long-term, an increase in exchange rate volatility has a considerable negative impact on export demand.

Equally important is the fact that Exports rise in response to (real) currency depreciations and decline in response to (real) currency appreciations. This might not always be the case, though. Over a two-year period, a gain in exports of 4.9 percent results from a real devaluation of 10%. However, exporters adjust to the “new normal” just one-third as quickly after a depreciation as they do after an appreciation. Exports decrease more quickly following (real) appreciations than they do following depreciations because of supply limitations, pricing to market, and informational frictions (Varela, 2022).

After the rupee’s fall in 2018–19, Pakistani textile and apparel exporters did not increase export volumes. The primary explanation for this is that changes in profit margins stabilize export prices in the local currency, and this effect is accentuated during depreciations: US dollar export prices react to fluctuations in the nominal exchange rate by 15% more than they do during appreciations. The more the exchange rate changes, the more asymmetrically export US dollar prices respond, demonstrating that purchasers level out Pakistani rupee pricing.

If we look at Pakistan’s experience with rupee depreciation, we can say that it has always resulted in cost-driven inflation and relentlessly harsh economic conditions. Pakistan has suffered significantly from currency devaluation both as a buyer and a seller. Devaluation of the Pakistani rupee will result in a devaluation of Pakistani labor and talent on the global market, which will act more as a stimulant than a medicine and lead to unheard-of inflation.

It is time to abandon the widespread misconception that exporters welcome rupee devaluation and end the practice of favoring excessively undervalued currencies. The central bank and government should concentrate on achieving an exchange rate that is competitive in the market and achieves actual exchange parity. The policymakers should create the right conditions for a maximal export response to currency depreciations. This will enable a conducive environment for not only exporters in general but also the economy. There has been no concrete step taken so far by the government to put a halt to the ever depreciating Pakistani currency. Moreover, given present situation, we are not in any position to raise bonds and have no access to capital markets anymore. This is of grave concern.

The Pakistani government must support the exporters in their efforts to get ready for the impending challenge by keeping up with the evolving economic situation. It needs to support the export drive as the dollars earned through exports are the cheapest, more sustainable with the added benefit of no compulsion to return them, no interest, and still the cheapest with only 3-4% cost. Hence, focusing upon dollars generated through exports are far better option than bonds. Pakistan has to make a quantum jump, but even if it manages to improve its export performance through textiles, it may have a better chance of holding onto and eventually expanding sustainable, export-derived, dollarized revenue.

Copyright Business Recorder, 2022

Author Image

Shahid Sattar

PUBLIC SECTOR EXPERIENCE: He has served as Member Energy of the Planning Commission of Pakistan & has also been an advisor at: Ministry of Finance Ministry of Petroleum Ministry of Water & Power

PRIVATE SECTOR EXPERIENCE: He has held senior management positions with various energy sector entities and has worked with the World Bank, USAID and DFID since 1988. Mr. Shahid Sattar joined All Pakistan Textile Mills Association in 2017 and holds the office of Executive Director and Secretary General of APTMA.

He has many international publications and has been regularly writing articles in Pakistani newspapers on the industry and economic issues which can be viewed in Articles & Blogs Section of this website.

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samir sardana Aug 03, 2022 03:21pm
Ideally Pakistan should try to navigate the PKR Into stability - but the SBP has no USD war chest and so no intervention,support or sterilisation is possible So what should be done ? Exports are of 3 types 1 - Nil Import and Deemed Import content - like Mining or Agri based on compost fertiliser 2 - Some Deemed Import content - Like Agri based on Chemical Fertilisers (Gas based) 3 - High Import Content - Like say export of fabric by importing yarn Now If USD rises - many commodities will fall and vice versa - and this trend and variability will change from time to time.This is the 1st risk for exporters - the commodity material price risk dye to USD changes Then USPR and T-Bills rates - impact the USD in varied ways and then the carry trades in Yen etc., which also hit commodity and stocks prices.This is the 2nd risk Then the 3rd risk is the PKR-USD.dindooohindoo
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samir sardana Aug 03, 2022 03:29pm
For Type 1 of Exports,since all costs are in PKR - they gain if PKR falls the most For Type 2 - THEIR USP is labour cost of conversion,as even a Factory in Somalia,can convert Imported material into merchandise.Pakistan has a power and gas shortage - so the KEY STRENGTH IS LABOUR COSTS AND PRODUCTIVITY - MEASURED IN USD ! BUT THIS WILL AID PAKISTAN ONLY IF COMPETITORS OF PAKISTAN EXPORTERS - HAVE LESSER FX DEPRECIATION,AND COMPETITION,DOES NOT HAVE TOO MUCH OF AN ADVANTAGE ON POWER AND FUEL ETC. For Type 3 - There is a problem,as he has to 1st import the GENERIC material,and then book export orders.In this period USD will move,AND THE ASSUMPTIONS MADE while export order pricing w.r.t. USD - might be blown apart..Also competition might ALREADY have the raw materials BEFORE THE EXPORT ORDER IS PRICED - SO HIS COSTS ARE CRYSTALLISED. So the Pakistani exporter has to hedge the FX risks on USD per se,AND IMPACT OF USD changes ON FOB RATES and CIF rates of Material imports.Type 3 needs a CONSULTANT
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samir sardana Aug 03, 2022 03:36pm
For Type 3 - There is 1 more problem,Say he 1st books the export order based on SOME ASSUMPTIONS OF USD AND Bill of Materials - and he promises delivery in 60 days (as he will import the material).But his competition who has the stock of material will give delivery to client in say 15 days and give 60 days credit ! OR The competition might have a shorter import supply chain and might be able to give delivery in 30 days Then the Pakistani exporter made an assumption on the USD ! Say USD depreciates - then Ceteris paribus,some material prices in USD might RISE ! The Pakistani exporters ONLY HEDGE THE USD PRICE RISK ON EXPORTS and not the impact of USD on the CIFFO rates of IMPORTED MATERIALS ! SO THE ASSUMPTIONS MADE BY THE PAKISTANI EXPORTER ON THE USD PRICING FOR FOB EXPORT AND THE ASSUMPTION ON IMPORTED MATERIAL COSTS CAN BE BLOWN APART THIS TYPE 3 EXPORTER IS HIT,BY FX VOLATILITY.dindooohindoo
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samir sardana Aug 03, 2022 03:43pm
BUT ......... IN REALITY - EVEN FOR THIS TYPE 3 EXPORTER, THIS FX VOLATILITY IS AN "OPPORTUNITY" to MAXIMISE NSR,CUT COSTS AND MAXIMISE PROFITABILITY AND PROFITS 1ST - IT REFLECTS THE QUALITY OF FINANCIAL MANAGEMENT OF THE PAKISTANI EXPORTER,AND ABILITY TO SERVICE CLIENTS, IN ALL FX MARKETS AND SCENARIOS 2ND - IT ALLOWS THE EXPORTER TO SELL PASS THROUGH PRICING,FOR INFORMED IMPORTERS 3RD - IT MAKES THE TENOR OF THE SUPPLY CHAIN - AN OPPORTUNITY AS OF TODAY , A PAKISTANI EXPORTER TAKES SAY 10 DAYS TO GET AN EXPORT ORDER THEN 10 DAYS TO PLACE IMPORT ORDER AND OPEN LC THEN GOODS REACH QASIM AND ARE CLEARED IN SAY 20 DAYS THEN MANUFACTURING TAKES 10 DAYS THEN EXPORT BL SOB TAKES 3 DAYS THEN NEGOTIATION OF EXPORTS TAKES 15 DAYS SO THERE IS A 70 DAYS,USD PRICE RISK AND A 10 DAY MATERIAL COMMODITY PRICE RISK ! BUT ...... THIS CAN BECOME AN OPPORTUNITY ! A CHANGE IS REQUIRED IN THE BUSINESS MODEL AND QUALITY OF MANAGEMENT
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