Ever since Shaukat Azizs tenure, economic managers at home are in a groovy kind of love with sticky exchange rates. They have fallen into Dutch Disease - in the last decade when all of a sudden foreign flows poured in, in the form of aid and investments; the exchange rate started to appreciate. Imports were becoming cheaper and exports suffered in the process.
The currency was kept around Rs60/USD for around 5-6 years and the imports grew by at CAGR of 19 percent during FY01-07 while the exports growth was limited to 11 percent. Mind you, there was not any energy crisis at that time to restrict exports growth. The artificially high exchange rate drove domestic demand higher due to the availability of cheap imports.
Eventually it led to a situation where we had to depreciate the currency suddenly in 2008 when the rupee slid by around 30 percent in no time. Since then (barring FY08 - exceptionally high commodity prices year), the imports CAGR (FY09-14) is down to seven percent. Due to energy shortfall, exports grew at an even slower pace of five percent.
The trend is clearly calling for a free float regime or a managed regime to lower the trade gap. On the contrary, Dars regime is clearly making the exchange rate an ego issue; not having learnt from past mistakes to correct the policy.
Times have changed globally as from double digit growth in 2005-10 world trade annual increase has slowed down to less than five percent and is likely to remain low in 2015. Various economies are adjusting currencies to maintain their respective share in international trade. However, at home unconditional love for sticky exchange rate is deriving the opposite result.
Non-essential imports have really grown up lately. There are two ways to tackle this; the better option being to let the currency finds its true value. However, the government opted for imposing regulatory duties on various goods to curb the demand for imports. What about boosting exports, who cares?
All that apparently matters is optics by showing artificially stable currency as an exhibit of economic management success. Really, is it a prudent approach? The only silver lining in exports is attaining GSP plus status for exports to EU due to which exports of garments have offset the fall in low value added textile exports. But rupees appreciation of 25 percent against Euro in past few months is eroding that benefit as well.
The question is what is the real value of currency is and what should be the outlook on nominal exchange rate given the governments conscious efforts to have a dirty float. The REER has moved down by 10 percent in the last 12 months and 18 percent since 2013. That is loudly calling for a downward adjustment in nominal exchange rate to help curtail the widening trade deficit.
Will that happen? At the time of falling commodity prices, especially oil, the inflation in oil importing countries has eased and in Pakistan lower monetary growth (an impact of previous years tightening) has further lowered inflation. Hence, the inflation differential is falling and adjustment warranted is probably far less than 18 percent.
The currency usually attains its real potential in the long run but the dynamics of capital flows normally determine its short to medium-term movements. The strengthening of dollar and recovery of American economy has diverted the global capital flows towards the US and that has resulted in weakening of various currencies lately.
The Euro is a prime example while the Russian currency fell like ninepins owing to sharp decline in oil and gas prices. The developing countries are facing the music as well. Indian rupee fell by 1.2 percent in the last week; Chinese Yuan touched a two-year low against USD, last week. Indonesian Rupiah has depreciated by four percent in the last month, Malaysian Ringgit is down by nine percent in the last quarter and the list goes on.
Why is it not happening in Pakistan? The simple explanation is drying up global capital flows from the country. That is why Pakistan is insulated from this strengthening dollar phenomenon. Is it good that we are shielded? Not really, rather our economic managers should be ashamed of the fact that FDI has dried up and FIPI is too low as its movement is not even enough to shake a highly illiquid market. What is alarming is that profit repatriation by MNCs is higher than fresh investment coming into the country.
So not for good reasons, Pakistans own dynamics would determine its short to medium-term exchange rate outlook. That is why the Finance Minister conveniently pulled the rupee-dollar parity back to Rs98/USD from Rs108/USD in Feb-March 2014. Ever since then, flows have started pouring into the country. SBP reserves are up from $3.1 billion (Jan 14) to $11.2 billion (Feb 15). There are more to come - disinvestment of blue-chip public companies, tranches from IMF, CSF money, and soft loans from IMF and maybe Chinese money which might also be in the form of loans.
Foreign exchange reserves are expected to reach $15 billion by June-end and growth may continue in FY16. Managing currency at current levels is easy. But one may wonder over the sustainability of this practice in the absence of foreign investment. $3 billion dollar poured in by Euro Bond and Sukkuk issue is used to retire governments debt on SBP. The money counterpart is not really created to spur domestic demand and so it may not help in reviving economic growth. On maturity, we have to retire the debt and its interest payments are due every six months. With no value creation, its eventual fallout would be worse.
Then the IMF money is just for Balance of Payment support and has to be retired eventually. The disinvestment of companies like HBL is like slaughtering the goose that laid the golden eggs- immediate relief at the cost permanently forgone dividends.
In a nutshell, its an unsustainable recovery and the way Dar is managing things, reserves ought to fall post 2018. At that time the domestic currency may fall sharply- reminiscent of 2008. Till then, the Rupee may slowly adjust downwards to build reserves and might stay around Rs102/USD, in the foreseeable future.