Pakistan is an import and consumer economy. Our imports stand at $ 57 billion while our exports stand at $22 billion. We imports expect to cross $60 billion mark during the current financial year. There is a huge gap between exports and imports. Every time when rupee depreciates against dollar we are told that our exports will benefit. The exporters love the devaluation of local currency against major international currencies. Because it made exports cheaper but at the same time it makes the imports expensive.
Our imports are two and a half times bigger than our exports, so devaluation of currency increased the prices and inflation. The high inflation hurts the consumers of low incomes badly. This implies that the economy could move from low inflation and high growth era to high inflation and low growth period. That is not desirable as this adversely impacts two fundamental objectives of economic management i.e. employment generation (worsens due to low growth) and affordability of goods and prices (falls due to high imported inflation, and high interest rates).
The need is to carefully evaluate the intended and unwanted outcomes of currency depreciation. Apart from inflation adversaries and its impact on growth through curtailed domestic demand, it could hamper fiscal balance by increase in debt servicing- both on foreign loans (direct impact) and on domestic debt by subsequent higher interest rates.
So if devaluation will not significantly increase exports and reduce imports, what else will it do? If we are a country largely dependent on imported consumer products and industrial raw materials, it will definitely increase the prices of all those products. Thus devaluation will result in inflation.
Inflation (of imported products) will increase the cost of fuel, transport, freight cost, electricity (which is generated from oil), gas (which we have now started importing), packaging materials (plastic and paper) and food (involving imported edible oil). So inflation, caused by devaluation, will not only increase the cost of living but also the cost of production. This increase in the cost of production will not only affect industries producing products for domestic consumption but also industries which are exporting. When the cost of production goes up manufacturers of exportable products will feel it necessary to increase their prices. Hence, even if devaluation does make exports cheaper it is most likely to be temporary.
Even in theory devaluation does not only impact exports and imports. Devaluation will decrease the current value (in foreign exchange) of existing foreign investment in the country. When foreign investors see their investments in our country being devalued they are likely to be discouraged from making further investments. Devaluation will also increase the cost of debt servicing in a country heavily indebted in foreign currencies (not just temporarily but permanently or for at least as long as the country remains indebted).
Devaluation of currency is in most cases undesirable and will have a negative impact on the national economy. Nevertheless, keeping a currency from being devalued artificially is not a sustainable solution (for a currency under pressure) either. The real and only solution is to adopt prudent fiscal and monetary policies so that the trade deficit is removed or remains within manageable limits and reduce dependence on foreign currency loans
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25 May, 2019