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Opinion

April 16, 2018

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Our economic quagmire

Our economic quagmire

If media reports are to be believed, the value of the US dollar has increased to Rs115 as per the inter-bank rate and stands at Rs119 according to the open market rate. The relevant authorities are of the view that Pakistan’s exchange rate was undershot. When it was left at the disposal of market forces, it rose to its equilibrium level.

If we consider the argument that market forces are to blame for this development, a series of question may arise. For instance, why did market forces result in the depreciation of the exchange rather than an appreciation? Why didn’t they generate the opposite effect? The answer is simple: the demand and supply of foreign exchange reserves (FER).

Pakistan’s exchange rate in terms of the dollar can be considered as the price of dollar in terms of the rupee. Economic thought suggests that the price of any item is determined by the forces of demand and supply. As a result, Pakistan’s currency has depreciated either due to the diminishing supply of foreign exchange reserves and an increase in the demand for these reserves.

If we examine the statistics of Pakistan’s economy, foreign exchange reserves have declined from $19 billion to $12 billion, which includes almost $6 billion of the reserves deposited with commercial banks. This, in principle, cannot be included within these reserves because they belong to citizens, not the state.

On the other hand, the country’s trade deficit climbed to $36 billion, which indicates the high volume of imports. In order to meet the needs of the import bill (at least for three months), the country needs foreign exchange reserves. Therefore, the demand for foreign exchange reserves has to increase. The burgeoning demand for foreign exchange reserves along with their depleting supply compels the exchange rate to depreciate – as it is happening nowadays.

The repercussions of a depreciating exchange rate are long-lasting and multidimensional. Countries like Pakistan, which are import-oriented, face problems in terms of escalating import bills and the increasing cost of production. An increase in the cost of production is directly reflected in the price levels. This negatively impacts the competitiveness of a country’s industrial sector and decreases the volume of exports.

Every economic policy has its pros and cons – and the same can be said about a depreciated exchange rate. In order to get the maximum benefits from a deprecated exchange rate, the country needs to do its homework and summon the political will to ensure economic welfare.

Pakistan needs to improve its production function that is aimed at gaining economies of scale. This will make the industrial sector more competitive and, in turn, improve the volume of exports, which will have multiple effects on the economy. For a country to achieve economies of scale, it needs inputs to be provided cheaply in order to produce output at a larger scale. For instance, electricity – a major input for any industrial unit – is not provided according to its rising demand. As a result, industrial units may not be able to produce at a potential level and, hence, cannot achieve cost-efficiency. When the exchange rate rose to Rs115 against the dollar, the cost of imported inputs also increased and directly affected price levels.

While the general elections of Pakistan are imminent and the final budget is likely to be presented by the current government in April, the intentions of the government are to restrict its expenditure on development projects and instead focus on non-development projects (which can be gauged from the pre-budget sessions). This will increase money supply in the economy without positively affecting the potential volume of the economy. As we know, a rupee spent on a non-development budget will have no impact on the output, but will increase the price level of the economy.

Disastrous economic conditions and limited political will leave the country in a crisis that the new government will have to deal with. It doesn’t matter which party wins the next general elections. Under such murky economic conditions, the next government will have no choice but to opt for another IMF programme to guarantee the country’s survive. As a result, we will be bound by restrictions imposed by the IMF and lose our economic independence.

All parties that are going to contest the general elections should have a clear economic policy within their manifestoes to tackle the current crisis. They should do their homework before assuming public office. Without this, it will once again become difficult for the next government to pull the economy out the quagmire it finds itself in these days.

The writer heads the department of economics at the University of Swabi.

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