The exchange rate has been stable against the dollar over the past few years. However it is time to assess what impact the ongoing dollar slide would have on the rupee and the economy.

Since July 2007, the greenback has depreciated against the euro by nearly 9.6 per cent, against the Japanese yen by 13.6 per cent and against the British pound by 2.9 per cent.

Over the same period, the dollar appreciated against the rupee, which went down from Rs60.48 to Rs61.37, a fall of 1.45 per cent, before making some recovery. The dollar has grown weaker in the past few years.

But, why should Pakistanis care? As long as the rupee is holding steady against the dollar it shouldn’t matter? Yes, that would be the case if all of our international trade and liabilities were denominated in dollars .

But a significant portion of our trade and a non-negligible part of national debt is in currencies other than the dollar. One has to assess now whether the dollar slide will benefit or hurt the economy.

The rupee’s depreciation against major currencies can encourage exports by making Pakistani goods cheaper.

A dollar depreciation against other currencies and slight depreciation of the rupee against the dollar means that rupee is depreciating against other currencies.

For example, the rupee has fallen from Rs81 per euro on July 1, 2007 to Rs91 per euro at the end of November, making Pakistani goods cheaper in currencies like euro, yen and pound.

If the cost an item, for example, was Rs5000 or $61 on July 1, 2007. it was reduced to $55 by the end of November---a nearly 10 per cent drop in price due to exchange rate fluctuation. Normally, this should result in an increase in Pakistani exports.

But is that likely to happen? There can be several reasons for why this may not happen. The Chinese yuan is steady against the dollar which means that prices of Chinese goods have also declined. On the other hand, our imports from these countries become more expensive in terms of local currency. This may not be all that bad if we want to slow down our imports to reduce the trade imbalance. But if the imports are of critical inputs like industrial raw material or machinery, it may hurt the economy and exports.

Fortunately, our single biggest import item, oil, is denominated in dollars and as long as the OPEC countries do not change their exchange rate parities, the exchange rate change should not have a big impact on the value of oil imports. Europe accounts for 23 per cent of our imports so a 10 per cent rupee depreciation could mean that imported goods will be costlier.

A dollar slide can also affect foreign investment. The US investor may be just as happy to invest but other investors may see their returns reduced due to the falling dollar and thus a weakening rupee. Fortunately, a substantial part of the private foreign investment comes from either the US or the Gulf who have their currencies pegged to dollar.

Over the last four years, an average of nearly 45 per cent of private foreign investment has come from non-US OECD economies such as United Kingdom, EU and Japan. A rupee devaluation against the pound, yen and euro could significantly slow down these investment inflows.

The dollar slide will also affect the Pakistani globe trotters or those who are studying abroad in non-US schools.

They will see their rupee costs rising dramatically. Finally, we might see non- dollar remittances fall in value. Since most individuals send a fixed amount in the home currency, a rupee deprecation means a smaller amount of foreign exchange is needed.

For example, now one only needs to send £79 to get Rs10,000 in Pakistan as compared to £82 in July. Fortunately, a majority of the remittances come from either USA or GCC countries, so the currency effect should be minimised.

The biggest and the immediate impact of the dollar slide is likely to be experienced in the external debt. Since our external debt is reported in dollars, an immediate impact would be an increase in reported debt due to the valuation effect.

Our debt payments which are not linked to the dollar are likely to be higher in rupee terms. For example, yen debt payments which were budgeted for this fiscal year will now cost more.

The depreciation of the dollar was not an unexpected event and there are no clear signals that government had planned for this contingency. The extra debt payments are likely to increase the budget deficit or development expenditure.

So now the question is, what could the government have done to avoid this? There is a need to do some stock-taking at State Bank of Pakistan and the ministry of finance and economic affairs division.

These institutions need to coordinate their efforts and actually start doing debt management instead of debt reporting.

Since the slide of the dollar was expected one option which the government should have considered was to go into the forward market for liabilities denominated in one of the currencies other than dollar. An important debt management tool which is missing is the use of hedge instruments. The idea is to match the currency of one’s liabilities (such as debt) with currency of the assets (such as reserves).

With over $41 billion in debt and liabilities and only $16 billion of reserves it will not be possible to hedge away all the risk but one has to make a beginning.

The government should inform the public about the share of debt in different currencies and the strategies it proposes to address the major interest rate and currency risk.

One silver lining in this cloud is that the dollar slide may encourage authorities to diversify their holdings of foreign exchange. Second, we may have more hedging instruments available in the market which do not just focus on the dollar alone.

The development of a forward market could go a long way in reducing the currency risk faced by investors, exporters and importers and could lead to higher potential investment and international trade.