It has to be gradual to avoid hyperinflation
Should Pakistan be devaluing its rupee to boost its exports and is there a sustainable relationship between currency devaluation and increased exports? This is a hot topic in the country these days and if the chattering economists are to be believed a significant devaluation is around the corner or rather has already started. And exactly by how much is anyone’s guess, but the general rumor in the air points to an ultimate correction of any where between 15 to 20%.
Pakistan’s current account deficit is ballooning and a devaluation is said to be at least a short-term answer to boost exports and curtail imports. The trouble however is that there exists no credible study or a real-time example to prove that currency devaluation does indeed (sustainably) boosts exports – Asian tigers, China, Bangladesh and India, all have managed a surge in their exports during a stable currency period and not through any abrupt devaluation measures.
In fact, on the contrary, a WTO study on value addition (2008) points to a stable currency environment as one of the main pre-requisites to a sustainable value-addition drive in an economy! Still, given our circumstances, one can somewhat argue the case of mild devaluation (5 to 7%, gradually) in order to help manufacturing competitiveness at least in the short-term, anything in excess of 7% though may well instead turn out to be counterproductive.
Amongst many other fall outs, a devaluation is invariably followed by a wave of inflationary pressures – especially in a current-account-deficit economy like Pakistan – and given that Pakistani exports in general are quite low on value-addition. For these two reasons alone (as a thumb rule) for a devaluation to justify itself on the simple promise of increasing national exports, it needs to in return increase them (in dollar terms) by at least double the percentage of devaluation itself; meaning a 5% devaluation should enhance net dollar exports by no less than 10% and that too within a fiscal year.
Further, since the overall base of our exports is also fairly small, one needs to be careful in computing gains or in arriving at precise trade-off calculations between any gains in exports (through devaluation) and the likely economic fall-outs such as: increase in foreign national debt in rupee terms; decrease in underlying dollar value of market assets (for example stocks); increase in short-term foreign currency liabilities borrowed to support FE reserves (again, especially in our case); raising barriers to capital investment in the economy (especially in plant & machinery); distorting dollar based targets of annual corporate revenues; and last but not least, unleashing of a sort of involuntary inflation tax on the common man.
And as for devaluation as a tool to discourage imports in Pakistan, there are two main concerns that come across as being worrying: 1) Pakistan’s imports to a large extent are inelastic and 2) Modern day management science has developed many other preferable tools than devaluation to curb or control imports, so why not instead use them first!
However, more importantly, about time that the Pakistani policymakers woke up to the reality that perhaps the days of the ‘manufacturing export-led growth model’ are over. Earlier this year in Mexico City, in a landmark joint presentation by Bruce Greenwald and Joseph E. Stiglitz, they argued that while undoubtedly the manufacturing export-led growth model created economic growth miracles in the 20th century, where East Asia saw unprecedented economic growth via exports, the model in today’s global reality has possibly become a victim of its own success .
In that today we are faced with a situation where productivity over the years has far exceeded the rate of increase in actual demand. Also, one is seeing that some vertical disintegration of the service components of manufacturing has in-effect resulted in a far greater (proportionate) loss of jobs in the manufacturing domain.
As .we know that a vertical disintegration in any sector’s chain can have strong negative implications on wages and knowledge-flow of that sector and naturally manufacturing has been no exception. Even with the emerging or the developing markets today taking up larger a share of manufacturing jobs – with a shift of say jobs from China to Vietnam or Africa over the last 5 years – the dilemma remains, as the new or modern manufacturing jobs only absorb a fraction of the new entrants coming into the labor force of these developing economies.
In short, while one can surely argue that manufacturing export-led growth still carries significant advantages to a country’s economic growth, job creation, earning of necessary foreign exchange and in building its manufacturing capacity without having to worry about domestic demand, the reality is that the modern-day world is unlikely to see a repeat of the growth success stories of China and East Asia achieved mainly on the back of the manufacturing-export-led model.
So, how exactly should these developments alter policymaking at home? The answer lies in instead exploring multifaceted growth strategy, with different facets reflecting different aspects of manufacturing-export-led growth. Export led growth naturally combined structural transformation and urbanization, movement to a learning economy, openness that meant one could simply focus on foreign exchange constraint (did one have the foreign exchange one needed?), and on job creation for new entrants into the labor force in order to maintain reasonably high employment.
But now in the new global model of growth the governments need to combine multiple-strategies wherein manufacturing is more directed, more limited, where possible, takes advantage of nation’s natural sources (minerals, oil, etc.), and compliments agriculture and services – Situ: conservation or preservation of components of diversity outside their natural habitats and in a shared policy environment.
And as for devaluation as a tool to discourage imports in Pakistan, there are two main concerns that come across as being worrying: 1) Pakistan’s imports to a large extent are inelastic and 2) Modern day management science has developed many other preferable tools than devaluation to curb or control imports, so why not instead use them first!
Finally, though deconstructing and reconstructing policy frameworks is all very good, the reality is that Pakistan faces problems with its external account now, which require an immediate solution and not merely a futuristic notion. Its exports are under threat, largely because its textile sector that (directly or indirectly) drives about two thirds of the total exports is faltering.
Given the widening current account deficit and with pressure on foreign exchange outflows likely to further increase in the coming months – external debt repayments, firming up oil prices, rising imports and fast increasing profit/dividends repatriation – boosting or at least stabilizing exports will be critical.
The main issue that confronts our manufacturing is that of competitiveness (difference of about 10% with regional competitors) and this is why some devaluation is essential in order to absorb the difference in the level of domestic-inflation with that prevalent in the markets we export to. And this is why despite being a strong proponent of a stable currency environment this writer recommends a rupee devaluation of around 5 to 7%, albeit gradually by March 2018.
Anything more will not only result in hyperinflation (difficult to tame), but also be damaging to our long-term growth prospects. History is full of examples where once confidence in a country’s currency wanes not only does it become difficult to arrest its decline, but also that of the markets it operates in!
