We should learn from Argentina and Brazil
If you want to boil an ocean down, do not ask for ways because there aren’t any.
With the entry of the Federal Investigation Agency entry into the black market for dollars, we are likely to witness a market failure evolving into a government failure.
The demand for dollars increases when the domestic currency faces volatility and there are scant opportunities for business and investment. It is a gloomy scenario. Usually, the economies on the verge of default, or scaling depression, behave in this fashion. Argentina and Brazil have undergone this phenomenon and to some extent, it still exists in both countries.
Pakistan has seen the best of times and the worst of times. But right now is different. It is bizarre perhaps. The government is showing good intentions, taking robust decisions, but the plight of the people is deteriorating out there.
At the moment the US dollar is short in the open market but available in the black market at a relatively higher rate fuelling the speculation. Let us look into it.
First, there are rumours that our financial managers have agreed with the IMF to further devalue the Pakistan Rupee, which may happen anytime soon. People are buying dollars to avoid the loss of the value of their money. Similarly, others want to make bigger gains in a short span of time. This is widespread and at places transactions are minuscule.
Second, when the central bank has both the exchange rate and interest rate in its hands, it loses precision in the capital market. This is also known as an impossible trinity in 101 economics. This has also aggravated the situation. Even though the positive flows of foreign reserves still exceed negative flows, the reserves are going out of circulation owing to speculative behaviour.
The government inspectors may enter the black market and may make headlines, but at the cost of leading the small black market into unknown spaces
Third, the government devalued the currency in the hope of boosting exports which would have eventually eased down the current account imbalance. However, exports have yet to pick up, while imports have become costly accordingly. As the economy was already undergoing an inflationary pressure, devaluation added fuel to the fire. To counter the inflationary trend, the central bank has been increasing interest rates for the last three quarters. But credit offtake is defying the increase in the interest rate and it may together with inflation bring the rupee even further down.
Fourth, spending cuts introduced in the beginning, aimed at reducing the fiscal deficit, are tantamount to pressure brakes applied to the economy. Consequently, it is slowing down with screeches audible, in fact quite aloud. Finished stocks are piling up, sellers are waiting and buyers are indecisive. In addition to this, those having money are perplexed. A few years ago, real estate offered a good investment opportunity. But due to government interference from multiple fronts, the property market is in the doldrums.
So what options are left with the general public having some savings at hand? Should they wait and lose the value of their savings or increase macroeconomic woes of the government by buying dollars and then stashing them away?
Ideally speaking none of this should happen. The onus lies on the government. The central bank must be accorded complete autonomy with a robust accountability mechanism. The central bank should establish its credibility and transparency of operations. In the short run, it should kill the seemingly abnormal incentive in dollar hoarding by categorically denying the rumours of devaluation. It can go one step further. An announcement of the exchange rate band would give a death blow to the dollar hoarding. To complement monetary initiatives, the government should also make fiscal adjustments on the expenditure side in order to create investment opportunities.
People cannot sit and wait. Time is a great driver. It makes its way. A government cannot control public behaviour when it is unable to provide choices. Argentina and Brazil tried it. They learned the lesson. We should also take a leaf from them. The government inspectors may enter the black market and may make headlines, but at the cost of leading the small black market into unknown spaces where it not only becomes elusive to traditional tactics but also grows in proportion.
