Impact of recent devaluation on the economy

by Muhammad Imtiaz Ali

The State Bank of Pakistan has recently devalued the rupee by 3.65% in relation to the US dollar. It was the seventh (7th) value adjustment since the beginning of the current financial year. Besides attracting exports to over come the serious crisis of foreign exchange reserve, and to improve current account deficit to stabilize balance of payment position. The other factor which might have forced the central bank to resort to one-go devaluation i.e. 3.65 per cent instead o creeping one, could be then existing considerable gap of around Rs.5/- per US dollar ($) between the Kerb market rate and official rate of dollar in Pakistan. It is the forces of demand and supply that determine the international price of a currency. In over case the principal forces of demand of the rupee include exports, foreign remittances, investments, short and long term loans, which create demand for the currency. While the main forces of supply are represented by transactions that increase the volume of rupee in the international market are imports, repayment of loans, payment of services charges and dollarisation of domestic savings. The pressure on the rupee accumulated from the burgeoning gap in the balance of trade which had widened to over 43.1 billion during the fiscal year 1995-96 against the background of continuing trade gap of about $400 million a month and certain heavy repayment in debt servicing in the coming few months, the pressure on rupee was immense. In the existing scenario of the forces of demand and supply, the rupee is expected to continue its downward trend. If the counter measures through cost-cutting and efficiency management are not taken to check the inflation, which is already running in double digit, the advantages of devaluation will be offset as in the past, leaving adverse impacts as our economy mainly depends on imported raw-materials, fuel, and capital goods. Which will certainly bring more hardship for common Pakistani people because our industry has substantial imported inputs in a wide range of locally produced goods and will also retard the process of industrialization in the country because of costlier machinery and imported raw materials. Similarly defence budget and debt servicing will cost more due to costlier dollar. The valuation of a currency in relation to US Dollar, Japanese Yen or any other major currencies of the world in terms of exchange rate is an important variable which helps in reducing the macro-economic imbalance by narrowing the trade deficit as well as generating higher growth rate in national income. The devaluation refers to the down-ward adjustment of the home currency vis-a-vis major currencies, especially the US Dollar. During the last one year besides periodical down-ward adjustments (depreciation), the Pak. Rupee was devalued by 7 per cent in October, 1995 by the Government in a quest to boost export

to help in improving the trade balance, influencing domestic price level, assisting domestic demand management and accelerating growth output. Moreover, following factors were largely responsible for devaluation of Pak. Rupees. * India massively devalued its currency * There was a decline in Foreign Exchange Reserves * The trade deficit was inflation * Dis-equilibrium in the balance of payment position. The main objective of devaluation last October was to make Pakistani exports competitive with India which had devalued its currency substantially over a short span of time. The devaluation was effected to boost exports to arrest disequilibrium in the balance of payments position. As Pakistan is following the managed float system of exchange rate, the State Bank of Pakistan (SBP) has to make necessary adjustments off and on in value of the Pak Rupee against different major currencies, which is not a devaluation but a worldwide phenomenon being experienced by all the countries following the managed float system. Under this system the exchange rate is linked to a basket of foreign currencies. The composition of the basket and the weight assigned to different currencies has been fixed keeping in view their relative significance in the international trade in terms of US Dollar Now let us have a bird's eye view of the balance of trade to examine the impact of devaluation. Pakistan suffered during 1995-96, a record foreign trade deficit of over $3 billion which is about 36 per cent more than 1994-95 and 74.2 per cent more than in 1993-94. According to the figures released by the Federal Bureau of Statistics recently exports falling 600 million dollars short of the budgeted target of 9.2 billion dollars to stand at 8.6 billion dollars despite high profile export moots abroad, incentives packages and repeated down-ward adjustments of the rupee. Imports also have gone up to $11.7 billion, $800 million more than the budgeted target of $10.9 billion, resulting in a worrisome trade deficit of over $3 billion. The major source of worry is that the export of almost all major goods, including synthetic textile fabrics, petroleum and its products, fish and its preparations, leathergoods, surgical instruments, fruit and sports goods has declined despite the 7 per cent devaluation of the currency and other incentives packages announced during the last financial year. The exports during the last year fell short of the target of $ 9.2 billion by about 6.5 per cent. However, these are up by 5.7 per cent over $ 8.1 billion of 1994-95 which has shown a growth rate of 19.6 per cent in exports. The imports during 1995-96 show an increase of 12.3 per cent over the preceding year. An important characteristic of the exports during the last fiscal year was the increased share of manufacturers in total foreign exchange earnings. These accounted for 78.3 per cent of the total exports mainly due to rise in the unit value of many items, as compared to 64 per cent during 1994-95. But the cotton products had the lion's share in manufactured exports i.e. 80.5 per cent when combined with raw cotton which brought $504.6 million, the cotton group accounted for 68.6 per cent of the total foreign exchange earning during the year.

The Federal Bureau of Statistics (FBS) confirms the apprehension that Pakistan may be losing its garments and knit-wear market abroad. Their export registered a decline of 7.8 per cent and 5.3 per cent respectively. Among other many factors, exports of carpet and surgical instruments improved by 4.82 per cent and 8.36 per cent respectively. However, the statistics show a setback to exports of sports goods and leather manufactures which fell by a sharp 17.3 per cent and 10.5 per cent respectively. Besides, synthetic textile exports also dropped by 21.4 per cent in spite of an agreement that was signed with the US Government last year which increased quota of this category by a substantial margin. The situation is alarming and calls for a thorough study to determine whether there is something wrong with the policy exchange rate determination and the incentive packages. Businessmen often complain of high taxes and ever rising prices of inputs such as electricity and gas to be a few of the major factors in making Pakistani goods uncompetitive in the International market. The policy of exchange rate manipulation so ardently pursued throughout the year, has not paid off and the goal of making exports cheaper and thus more competitive in the world markets. The fact that our industries are yet heavily reliant on imports for their requirements of capital goods and raw materials whose costs rises as the value of rupee declines, offsetting any pricing advantage expected for exports as a result of devaluation. As import becomes expensive by imposition of additional levies like regulatory duties etc. it also pushes the cost of exportable item since 67 per cent of the national imports are basic industrial requirements which serve as capital goods. Under the existing circumstances of the country no major change in import/export scenario could be brought only by tariff rate structure or currency adjustment. There is need to bring about basic structural changes in the economy to stimulate exports and substitute imports.

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