Currency devaluation

Is it Pakistan’s turn?

Pakistan’s economy has been losing out to nimbler rivals in the export game. Citing a loss of competitiveness caused by increased costs of doing business in the country, manufacturers have seen their export market share hacked away by regional competitors. The Textile industry in particular has been badly hit. The industry is in a state of near constant panic, undergoing a slow, painful decline in exports, watching their business gradually trickling away.

Policy making in Pakistan is akin to handling wafer thin glass with a pair of tongs. It requires great skill and luck to get the job done. Few variables are within the Government’s control, those that are need to be tweaked with utmost care. Anything too drastic is liable to bring down the house.

The global economic slowdown has added a dimension of increased market competitiveness, especially among relatively low-tech, mass market products such as textiles. Europe’s economic malaise, now bordering on chronic, sub-par economic growth, has not helped either. As an important export destination for developing countries, the loss of a growing European market has only intensified competition amongst developing countries in the low-tech sectors. Pakistan’s inability to compete, whether through years of underinvestment in infrastructure, machinery or due to the rising cost of doing business coupled with energy shortages, has resulted in the country being elbowed out by the competition.

In such a situation, two options present themselves. Option number one is a long-term, meandering shuffle towards increasing productivity through less arbitrary regulation by the government, ensured energy supplies and efforts by the private sector to increase its focus on research and development. The idea is to produce more with each unit of input, thereby lowering per unit cost.

The other route is a short term, steroidal boost to the economy through devaluing the Rupee to bolster competitiveness. This entails devaluing the Rupee to make Pakistani exports cheaper for foreign buyers, thereby re-establishing the country’s price competitiveness in the international market. The use of devaluation is a popular measure among developing countries looking to boost exports in the near term. China has been devaluing the Yuan to get rid of production overcapacity and to avoid a deflationary spiral.  After reaching the limits of a debt-fuelled spate of economic growth, the Chinese are looking to maintain their growth trajectory through an increase in exports. The Egyptians have also recently devalued the Egyptian Pound recently to improve flagging growth and ease an impending balance of payments crisis.

The mechanism behind a devaluation led export growth is fairly simple. Exporters are allowed that extra breathing space in negotiations since their prices are likely to be fixed in local currency terms, a devaluation has the effect of lowering prices of local goods in the foreign currency, making export prices more favourable for the foreign buyer.

A devaluation is not without consequences through. Export rivals such as Bangladesh might be tempted to trigger their own round of currency devaluations. Through to be fair, a devaluation of the Rupee is not exactly headline material and hence unlikely to trigger reprisals from regional competitors. The advantages of a devaluation would only hold in cases where regional rivals keep their own currencies’ values constant, allowing the Rupee to get away with a relative price advantage in the international market.

A currency that has been allowed to devalue is likely to transfer inflationary pressures on to the host economy, as the local currency price of imported goods goes up. The stability of prices in Pakistan is a relatively recent phenomenon. During the 2008 democracy-dictatorship transition inflation topped 20% per year. For a country with large sections of society vulnerable to changes in the price of goods, significant fluctuations in the price level need to be afforded great importance. Plus, given Pakistan’s dependence on imports for a majority of its energy needs means any devaluation is likely to result in increased energy prices being passed on to consumers, as has been the case historically.

There seems to be a general fatigue amongst Pakistanis regarding the inflationary squeeze over the past years. Competitiveness or not, the public is unlikely to take kindly to any inflationary surprises.

Considerations are also due to Pakistan’s alleged game changer project, CPEC. For local partners importing equipment, a devaluation would eat away at profits, unless the company has arrangements whereby it is protected against currency movements. For Chinese companies operating in Pakistan, being paid in Chinese Yuan, a devaluation will not impact profits but for those being paid in Rupees, profitability will suffer.

Followers of the Chicago school would be dead against any government intervention in the market, instead allowing currencies to establish their own place and price according to what the market sees fit. The main thrust being that the market knows best. The Finance Minister disagrees, of course, given how he made it his mission to maintain the Rupee’s exchange rate. Which worked out in Pakistan’s favour; stability was provided when stability was greatly needed.

The process of devaluation can be a tricky, messy business. There is always a chance that the process will take on a momentum of its own, turning neat spreadsheet analysis into a currency rout. A fragile economy leads to uncertainty amongst agents and uncertainty leads to panic. Unlike China where the state has hundreds of billions of foreign exchange in reserves and where operators are sure as to the outcome of a devaluation; Pakistan’s economy is riven with uncertainty, finely attuned to negative signals and hence to prone to bouts of panic. There is a real chance of a controlled devaluation turning into a Rupee freefall, something on the lines of the Asian financial crisis where, at the IMF’s insistence, a number of Asian economies started the process of currency devaluation, only to find the process taking on an overwhelming force of its own; sending the currencies into an uncontrolled downward spiral.

The risks are great and the benefits fleeting, especially for an economy that is dependent on external energy sources for its needs. A devaluation, while good for a short term boost to exporting sectors, is likely to throw up a host of other challenges that could prove to be detrimental to the country’s economy and general stability.