THE State Bank of Pakistan’s reduced policy rate, coupled with a depreciating rupee, is expected to make the country’s exports more competitive by cutting the financial charges of companies and enabling exporters get more rupees for a stronger dollar earned.

This may also provide some breathing space to export-oriented industries, which are finding the going tough in the international market owing to their high cost of doing business.

Similarly, with lower interest rates, the government’s borrowings would be less costly and positively impact the consolidated fiscal deficit managed by the federal government with targeted surpluses provided by the provinces. It may partly compensate for the rise in the servicing of foreign debts as a result of the falling rupee.

The lower interest rate may not hit the banks’ profitability by much, as, according to financial analysts, they have made huge long-term investments in Pakistan Investment Bonds. As it is, the banks prefer risk-free investment in government papers while the private sector finds it more convenient to self-finance business activities with its own earnings and savings.

If the rupee depreciates or if export subsidies are doled out, foreign buyers immediately seize the opportunity to get the benefits in a globally competitive market. The exporter’s gain is limited

A quick glance at listed companies’ balance-sheets shows that financial charges are being reduced or eliminated, with leveraging not so much in fashion at this point of time.

With the national currency depreciating, one can assume that costlier imports may also help cut imports and reduce the trade gap.

But decades-long experience has shown that adjustments in the exchange rates and changes in the interest rates serve as temporary measures and are not enough to reduce the trade deficit to a manageable level or tackle the balance of payments problems with ease on a durable basis. They have led to more frequent access to the IMF’s credit facility and increased the debt burden.

If the rupee depreciates or if export subsidies are doled out, foreign buyers immediately seize the opportunity to get the benefits in a globally competitive market. The exporter’s gain is limited. A stronger dollar also makes the import of industrial inputs — machinery, equipment, new technology, raw materials, chemicals etc — costlier (no doubt with some time lag), and wipes out part of the gains from the rupee’s devaluation.

Thus, much of the competitive edge is available for a short span of time. These ‘windfall’ gains from the continuing currency devaluation also divert much-needed focus from productivity, quality and value-addition. Pakistan is losing even its textile markets to late comers like Bangladesh and Vietnam.

The exchange rate is market-driven — which includes speculative activity harmful to the real economy — while the purchasing power parity (PPP) of different currencies in the global exchange of goods and services is completely ignored. The gap between the PPP and the market rates is wide and results in a huge transfer of resources and wealth overseas.

The problem assumes a much bigger proportion during the exchange of low-priced goods produced by emerging markets and costly capital goods sold by the developed world, accentuating the trade deficit and balance of payment problems. By and large, the terms of trade with the west have been against emerging markets like Pakistan.

Though the fluctuating interest and exchange rates may be seen as better devices to absorb exogenous shocks as they emerge — rather than postpone the day of reckoning by retaining the fixed rate to the maximum possible stretch — this has discouraged corporate borrowing and investment generally.

The depreciation of the national currency raises the cost of investment in case of imported capital goods on which we depend heavily, having failed to develop a capital goods industry. In fact, the banks are also reluctant to finance long-term investment except for selected cases.

The credit-based international financial model evolved since the early 1970s with the floating exchange and interest rates has produced more global crises than witnessed ever before and seems to have run its course.

A radical deviation from the current course may not be feasible within the existing framework of broad macroeconomic policies earlier designed by Pakistan to create an export-oriented economy.

In the current transitional phase of the global market, the policymakers should return to the import-substitution policy adopted in the 1960s. For this, a restrictive foreign trade policy may be required for some time, to be coupled with a free domestic market. Globalisation should proceed on the basis of self-reliance.

And no less importantly, foreign trade needs to be linked with the fastest-growing economies, preferably in the region/neighbourhood, to ensure that the country buys from the cheapest source and sells in the most lucrative markets.

Published in Dawn, Business & Finance weekly, September 21st, 2015

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