Devaluation will be a mistake

The step to avoid

Rumours are abuzz that Pakistan Rupee (PKR) is likely to be devalued any time soon. There is a lot of pressure on the government that perhaps the only solution to resurrect falling exports lies in devaluation and therefore should be done quickly. The IMF (International Monetary Fund) also believes that the PKR is overvalued by as much as 17% and is recommending a quick adjustment to its international parity. After an initial fall in 2013-14, the State Bank of Pakistan and the Ministry of Finance had intervened and were able to shore up the rupee bringing the parity then to around 98PKR:1USD and an average rate parity (during the last fiscal year 2014-15) to around 102.80 – today it stands at around 105 Pak rupees to 1 US dollar. IMF being the principal lending organisation to Pakistan, naturally its observations and recommendations carry a lot of weight. Its rationale being that a downward exchange rate can play an important role in quick and sustainable accumulation of reserves (in their opinion still a major current challenge for Pakistan economy) and in increasing our exports.

One can only hope that Pakistan government does not accommodate this view of IMF, because nothing could be worse for the long-term interest of our economy than embarking on another senseless devaluation spree. In fact, the State Bank of Pakistan should issue a statement, in no uncertain terms, clarifying that not only it has no intentions of any major rupee devaluation in the immediate future, but that it will also do everything possible to safeguard the rupee’s value – “to safeguard the national currency”, in the classical textbook sense which is by the way also the foremost duty of any central bank.

However, more importantly, the government itself needs to be convinced on why devaluation will not help our economy’s cause. And there are a number of reasons why. First, devaluation may not really help boost exports. Textiles constitute bulk of our exports (between 55-60%) and perhaps the only real manufacturing industry that operates at global competitiveness. The other exports in services, gems and jewelry, furniture, fisheries, information technology, etc are either design, skill or niche based and price is only one of the many factors (and that too not a major one) influencing customers’ buying decisions. So really when an argument is given to raise Pakistan’s manufacturing competitiveness through devaluation, it primarily applies to the textile sector. But the trouble with this argument vis-à-vis Pakistani textile exports is that the cost of doing business at home has primarily gone up due to poor environment and governmental inefficiencies and a devaluation would in-effect just end up subsidising governmental inefficiencies.

Further, in textiles, the devaluation argument is never a simple one since marketability needs to be also looked from different perspectives, meaning how price elastic is the demand of given product(s) in the global market. Pakistan’s textile exports are by and large amongst the lowest in terms of value addition, on average about $4.50/kg. Whereas, on the other hand, China is in excess of $20, India $12 and Bangladesh at around $10 per kg; implying that a simple price reduction may not necessarily help sales.

What is required is to encourage the industry to add value by way of resorting to economies of scale, innovation and entrepreneurship. And to achieve this the government needs to focus on solving energy issues of textile industry and to undertake some basic structural reforms: cut down on red tape, facilitate human resource development, minimise the contact between the business and the regulator, improve law and order situation, and reduce barriers to forming a productive manufacturing environment. Also, Pakistan’s domestic per capita consumption of textiles is quite low – often considered as also the principal barriers to ‘Brand’ formation – and given our high installed production capacity there is heavy reliance on international markets. The government needs to support brand-formation, which in the long run will also help raise our exports’ dollar value. In short, meaningful growth in Pakistani exports is going to come from fixing our supply side bottlenecks and not by devaluation.

Before going further, it may be helpful to study the history of economies that have had major export breakthroughs over the last two decades – mainly, India, China, Brazil and Bangladesh. India has jumped from exports of merely $25 billion in 1991 to nearly $300 billion today, China’s meteoric export-climb since 1989 (year of its joining WTO) is well known, Brazil tripled its exports from 1997 to 2007 and Bangladesh’s has climbed from meager $4 billion to over $35 billion. However, point to note in all these success stories is that this high growth in their exports took place amidst a period where their respective currencies remained fairly stable. In fact, in cases of China, India and Brazil, if anything, their currencies in this period of growth actually tended to be firm against other major global currencies. Also, the cases of Malaysia, South Korea and Singapore have been no different. Supporting this, China’s leading Fudon University and its WTO Secretariat have a joint study to their credit on how exports both in quality (innovation and value addition) and quantity terms benefit in periods where there is economic and exchange rate stability and how it suffers during times of frequent currency jolts. The study also elaborates on how countries indulging in frequent devaluations in essence self-create a barrier of ‘capital cost’ for entry into a high-tech or value-added sectors, which then relegates them to a ‘capital trap’ of low-end manufacturing leaving little chance for future upward mobility.

Second, we must keep in mind that Pakistan has almost always been a country with a current account deficit (CAD), meaning our imports have exceeded exports. And it is pertinent to note here that the bulk of our imports are inelastic in nature since they constitute essentials like fuel oil, edible oils, food items and pharmaceuticals — devaluation would mean a higher CAD.

Third, Pakistan’s external debt (in foreign exchange) is very high and devaluation would mean a jump in our external liabilities by as much, and that too without providing any additional capital value against assumption of this additional liability.

Fourth, Pakistan is moving through some very challenging times vis-à-vis geographical and political security situation both at home and abroad. This means that our defence forces will require extra funds at their disposal, especially when our neighbour is regularly upping the ante by increasing its defence budgets. As defence equipment is still largely outsourced, devaluation at this stage could seriously compromise our ability to successfully manage our security needs.

Finally, an eroding currency value is invariably accompanied with multiple economic undesirables: it stokes inequality as prices at home spiral, in turn widening the income gap and adversely affecting fair distribution of economic opportunities; high capital costs favour monopolies and make startups so much more difficult; real estate prices often move beyond the reach of the common man and in cases also beyond that of the middle-income category; devaluations are automatically linked with dwindling fortunes of an economy since a poor resultant perception cum loss of national confidence leads to flight of capital; it stokes corruption as the corrupts’ ill-gotten foreign wealth portfolios multiply over night; and last but not least requires a sea change in on-going policy choices. As an example, all calculations on privatisation benchmarks will need to be revisited since both the replacement cost and the intangible anti-trust value of a state run enterprise will become so much dearer.