The Causes Of Pak Rupee Devaluation

The Causes of Pak Rupee Devaluation During the month of May’08 Pakistan Inter-bank and Kerb forex markets witnessed a sharp decline in Pak Rupee value versus US$. Despite the Central Bank’s intervention and some regulatory steps, Pak Rupee continuously losing its value. Under a floating FX rate system, the exchange rate decline is expected & a necessary component of the adjustment mechanism. There are so many factors that cause currency crises to occur, i.e. economic, political, corruption, etc., but to determine the route causes of current crises, let us focus only on the major economic variables, these variables are interlinked with each other, therefore, it cant be sure that which one triggers the other: a) Price shocks (Includes decline in Export commodities prices or inclined in Import commodities prices) One of the major and most discussed cause of current crises is the ever-rising price of imported crude oil, which hit close to a record $127 a barrel on May 15 and an all-time high of $128 a barrel the next day amid widespread fears over stretched global energy supplies. b) Expansionary fiscal or monetary policies adopted by the previous government in order to stimulate the economy, and which cause aggregate demand to grow at a pace higher than domestic supply. The gap between aggregate demand and domestic supply is filled by imports. The result is that imports grow more quickly than exports. Current account deficit goes up, which has to be financed through either falling foreign exchange reserves or capital inflows. Capital inflows, however, may not be forthcoming because of lack of trust in the country’s financial situation. c) Fiscal deficit, previous Government resorts to borrowing from the central bank or from foreigners to meet huge PSDP expenditures. Borrowing from the central bank increased the inflation. High inflation is proved lethal for export, because it distorts prices. In particular, inflation increases the input cost of exportable goods and makes them less price competitive. As far as foreign liabilities are concerned, Pakistan total external liabilities surged to $45.822 billion by the end of March 2008, compared to $42.882 billion on December 31, 2007. Although former Prime Minister Shaukat Aziz and his team of ministers claimed that their government had broken the begging bowl, figures of the State Bank of Pakistan (SBP) showed a different picture. Five years ago on June 30, 2003, total external liabilities of the country stood at $35.439 billion. The break-up of figures shows that public and publicly-guaranteed debt increased to $40.479 billion by March 31, 2008, which was $37.836 billion on December 31, 2007

d) Weaknesses of domestic financial system also contribute to the eruption of a crisis. Foreign capital plays an important role in economic development. However, in many cases capital inflows have been volatile. Increased capital flows have been followed abruptly by equally massive capital outflows. Countries with weak and untransparent financial system are particularly vulnerable to this problem, as happened in case of the Pakistan. The massive foreign home remittance inflow after 9/11, abruptly over stimulate the Equity, Real Estate and essential/luxury commodities markets, in fact our financial system and economic managers has failed to utilize massive inflows into capital and capacity building spending. e) Capital flight, low Foreign Direct and Portfolio Investments are another major contributors of current crises, it is also clearly witnessed by KSE tumble. Foreign investors preferred pulling their liquidity out of the market due to the prevailing political and economic landscape. This capital outflow will result a fall in SCRA (Special Convertible Rupee Account). Foreign Direct Investment in Pakistan during July-April 2007-08 dipped by 16.7 per cent year-onyear to $3.48 billion and portfolio investment by 93.3 per cent to $119.4 million as compared to the corresponding period of the previous fiscal year f) Speculative Pressure, in emerging markets like Pakistan speculation always remains the major factor behind an exceptional behavior. In current crises the speculative factor was further aggravated by the lack of availability of US$ at local Kerb market. Some banks on the other hand engaged in excessive trading activities, that create undue panic, and they also encourage their export clients to delay the realization of their remittances. According to the State Bank of Pakistan, the country’s total liquid foreign reserves further declined by $48.7 million during the first 10 days of May, 2008, to $12.207 billion on May 10. Thus, foreign exchange reserves have now declined by $4.293 billion from $16.50 billion less than a year ago. g) The Real Exchange Rate: Real FX rate = The relative price of two identical baskets of goods in the two countries. Increase in the real exchange rate creates currency devaluation pressures, because it hurts all firms that are exposed to foreign competition. Exporters suffer, because their costs are higher when measured in terms of foreign currency. Firms facing import competition are hurt, because foreign producers are under no pressure to increase prices with domestic inflation. The impact of an increase in the Real Exchange Rate depends to a great degree on the Trade to GDP ratio, an appreciation of the Real Exchange Rate of a country with a high Trade

to GDP ratio is particularly worrisome because exports are not competitive in world markets, and imports capture a greater market share in the domestic market. By considering the density and the consequences of current Pak Rupee devaluation crises, it could not graded as a similar or much bigger then, 1997 South East Asian Countries Crises, 1998 Russian Rubble crises or 1994 Mexican peso crisis. Some, experts firmly believes that it’s a speculative pressure which may not go too far, due to some upcoming major influx of US$ into domestic market, and rupee should eventually stabilize around Pak Rupee 65-66/US$ bend. * Budgetary support from ADB, China and KSA Billion * Budgetary support from UK, Japan & GCC Countries Billion * Lucky Cement GDR Billion * MCB Bank’s Stack sale to Malaysia’s Maybank 0.674 Billion

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1.45

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