Pakistan’s currency troubles
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On a recent visit to Pakistan, noted economist Arther Laffer reminded us that inflation can only be countered if the economy is rooted in sound money. In simple words, to bring down high levels of inflation, a country will need to find a way of increasing the supply of goods and services while keeping the quantity of money at a manageable level, and faster inflation rates imply faster loss of the currency’s value.
On the sidelines of this presentation there were other important interventions. For example, it was discussed how a small open economy like Pakistan is prone to fluctuations in commodity price abroad. Large import requirements of oil, food, industrial inputs, and consumer goods result in higher demand for the greenback. The rapid opening up of industry after the second wave of COVID-19 has meant that input shortages globally resulted in higher prices of intermediate goods demanded by factories. The global chip shortage was just one example, whose ripples could be seen in auto, construction, and several other large-scale manufacturing activities.
Then we also understand that in economies with external security threats, demand for liquid assets including foreign currencies remains upbeat. When the threat perception is high, speculative demand for the US dollar also rises – something seen recently in Pakistan, Iran, and Turkey.
More recently, it was said that Pakistan may even end up supporting the import needs of Afghanistan. According to the Finance Advisor, large amounts of imports for Afghanistan were processed from Pakistan after the takeover of the Taliban. This led to a falling value of the Pakistani currency in the kerb.
In view of the above mentioned, the central bank has done something which should remind all of the memories of Pakistan’s action after the nuclear tests in the late 1990’s when foreign currency accounts were frozen. This time, the central bank has fixed a maximum limit of $100,000 per person per calendar year for buying of foreign currency from privately managed exchange companies. SBP has also demanded to obtain an undertaking from individual customers at the time of each transaction exceeding $1000. These administrative measures are now bound to strengthen the parallel forex market that already continues to exist. Those who participate in this parallel market know fully well that there will be a future time when this or the next government will invite them back into the formal channel and even offer amnesty for tax purposes.
Pakistani children will be poorer than their peers in Colombo, Dhaka and Delhi if economic fundamentals do not turn around and do so quickly.
Dr. Vaqar Ahmed
Such administrative measures are mostly counterproductive. These measures are never a solution to curb the flight of the dollar. It will be timely for all organs of economic administration to ask hard questions now. Why is all this happening at a time when the government claims respectable levels of foreign exchange reserves, decent exports and remittance levels? There were also claims that coming out of COVID-19 earlier than peer economies will help extend short term gains in the external account much further. In reality, the growing trade and current account deficit took many by surprise during 2021.
What went wrong here is a) the government’s weakness in walking the path committed at the start of the fund programme, b) the Prime Minister’s lack of confidence in the economic team resulting in frequent turnovers at the Finance Division, Ministry of Energy, and FBR, and c) the government’s desire to continue with ‘look good’ spending even if it came at the cost of higher levels of fiscal deficit, again resulting in higher levels of inflation.
In 2018 there was, and now in 2022 there still is, a hope that the country will sail through without the necessary reforms agreed with the fund. The naive expectation of a friendly country, perhaps Saudi Arabia, continuing to forever provide limited time ‘gift deposits’ remains alive. The perception that China will forever be there to save us from defaulting just because it needs us is also misplaced.
While all these permutations are taking a painstakingly long time to think through in Islamabad, the clock is unfortunately ticking. As the speculative behaviour in the forex market continues to impact inflation adversely and contribute to external debt burdens, the fact is that we are leaving our future generations with reduced purchasing power. In other words, Pakistani children will be poorer than their peers in Colombo, Dhaka and Delhi if economic fundamentals do not turn around and do so quickly.
What is more unfortunate is that the big picture is still missing. Not a single Cabinet member has been able to present a longer term vision of economic correction. Problems are well presented, and solutions are comprehensively explained to the masses. But no one is being able to steer this crippled economy from point-A to point-B.
The elite class in general has also taken a docile position. Not advocating and lobbying for economic security as the single most important priority is despicable. But then rent seekers in any setting have skewed interests; why would they need to give a public interest call and fight for intellectually burdensome sustainable development goals (SDGs).
– Dr. Vaqar Ahmed is joint executive director at the Sustainable Development Policy Institute (SDPI). He has served as an adviser to the UN Development Programme (UNDP) and has undertaken assignments with the Asian Development Bank, the World Bank, and the Finance, Planning, and Commerce Ministries in Pakistan.
Twitter: @vaqarahmed
