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The original news article based on which this commentary is written can be found here.
This article discusses the state of the Pakistani rupee in the nation’s current economic
context. The rupee has suffered a sustained depreciation to the dollar due to Pakistan’s
widened current account deficit and fiscal overspending, amidst the nation’s steady recovery
from the COVID-19 economic crisis.
Due to the rapidly changing state of the global economy caused by the
macroeconomic shock, conclusive future forecasts became extremely difficult to make, and
the government, fearing higher unemployment, was forced to adapt and prioritise
expansionary fiscal policies. The current account of a nation’s balance of payments is a
record of the balance of trade of goods and services, as well as a country’s transfer payments
and net investment incomes. Pakistan’s current account deficit seems to be primarily fueled
by the disproportionately higher expenditure on imports compared to revenue gained from
exports. A balance of trade deficit paired with fiscal stimulus promoting imports may
exacerbate the issue of inflation already arising in the nation. When not rectified by capital
flows such as foreign reserves to defend the currency, it is only at risk of further depreciation.
The above diagram illustrates the depreciation of the Pakistani rupee (Rs) against the
dollar from December 2020 to December 2021. The initial supply of rupees from Pakistan
(S1) and the demand for the currency (D) from the USA intersect to form the equilibrium
point a, representing the price of Rs in US$, in other words, the exchange rate. The value of
the rupee against the dollar initially stood at 159.83 (approximately 0.0063 US$ per rupee).
However, Pakistan’s attempt to revive its economy following the pandemic led to fiscal
overspending, which boosted consumption and investment, incentivised imports, and
eventually led to a current account deficit. Due to the disproportionately high expenditure on
imports, more rupees are exchanged for foreign currencies (among which is the US$),
shifting the supply curve from S1 to S2. Due to the shift in the Rs supply, the equilibrium point has moved to point b, at which the exchange rate falls, indicating a depreciation of the
currency against the US$.
Throughout the beginning of the pandemic, the government’s attempts to combat a
fall in average prices by implementing expansionary fiscal policies proved to be successful.
However, the resulting demand-pull inflation may have further spiralled due to low interest
rates. Consumers turned to imports due to a surge in domestic costs. The government was
also required to import millions of COVID vaccines in this period. The resulting current
account deficit became difficult to rectify due to the depletion of foreign exchange reserves,
preventing Pakistan from changing the rupee supply in the foreign exchange market, in the
form of reducing the supply and raising the nation’s exchange rates. Thenceforth, however,
global commodity prices began to rise, and delays in (now expensive) import payments
further destabilised the rupee against other currencies. Due to the heavy reliance on cheaper
imported goods, the sudden rise in import costs may have also exacerbated the current
account deficit.
The rupee is volatile to frequently changing global commodity prices and external
determinants, many of which cannot be predicted. In theory, targeting further depreciation
may be a solution to a current account deficit, if the price elasticities of export and import
demand satisfy the Marshall-Lerner condition. It is possible that the combined rupee
depreciation and the widened current account deficit may only be temporary (due to the rapid
rise in global prices and time lags in import payments, and not a policy implementation
issue). However, Pakistan has experienced long-term rupee depreciation since late 2020,
suggesting that the conditions are likely not met and that any further depreciation will only
worsen the deficit.
However, if global commodity prices do eventually fall, Pakistan could regain their
competitiveness through export-oriented industrialization, a structural adjustment promoting
economic change. More inexpensive imports may also lead to lower production costs and
thus incentivise domestic consumption due to lower prices. If the government cuts back on
fiscal stimulus, structural change is essential for Pakistan to regain their international
competitiveness and export potential in domestic industries, to rectify its current account
deficit. This could be targeted through supply-side policies incentivising innovation and
production.
Amidst the global pandemic, many nations experienced some form of temporary
deflationary pressure. Despite its evident consequences, it helped correct disequilibrium in
the current account of their balance of payments, due to reduced overall consumption and
investment, paired with increased import restrictions. Therefore, by the time their economies
had recovered, their current account deficits had also been rectified. This suggests that
indeed, in such an unpredictable global economic context, Pakistan’s efforts to stimulate
investment and consumption may not have been very effective, and that they must now
discard previous policies to prioritise reducing their current account deficit and stabilising
their exchange rates.