If one was to pick the worst economic decisions in the history of economic decisions made by Pakistani policymakers, the Dar peg would easily be among the worst, given the disastrous economic consequences that it entails.

The consequences, which are already beginning to manifest, will significantly erode the purchasing power of all segments of the population — except the rent-seeking class, which continues to be protected by every policymaker and politician at the helm.

The global commodity supercycle

The year 2022 started with volatility both on the political and economic fronts. Globally, the commodity supercycle was peaking as a post-pandemic demand surge pulled up prices of commodities across the board.

Pakistan, being a massive commodity importer, continued to pay ever-increasing prices for commodities across the spectrum, whether it was petroleum products, or something as basic as edible oil, or pulses. Pakistan’s structural weakness remains its heavy dependence on the import of staple products — a problem that needs to be fixed, as it is already too late.

As the commodity supercycle kept gaining traction, political volatility in Islamabad took attention away from economic decisions that would affect the whole population. As those at the helm consider ‘being selfish’ a value, the decision to fix fuel prices seeded the perfect storm.

As the government changed following the vote of no confidence, the incoming policy makers did not take any corrective actions either, and continued the policy of fixed fuel prices, accumulating the costs that would have to be paid by the population of the country only a few months later.

Although some decisions were taken to expand the tax base, improve liquidity of foreign currency, and let the PKR depreciate to a more market-oriented level — potentially avoiding a sovereign default — since level-headed decisions are not welcome by the political elite, there was a change of guard, resulting in the emergence of the gentleman famous for obsessing with a fixed exchange rate.

Looking at a more macro picture, all economic problems of the country during the last many years can be linked to an obsession with maintaining arbitrary prices.

Read more: Return of the ‘Dar’ Ages

The narrative that enabled the return of the gentleman obsessed with a fixed exchange rate was another spiel of fixed exchange rate that envisaged the appreciation of more than 15 per cent of the Pak Rupee against the US dollar at a time when reserves were dwindling, and the country barely had any foreign currency to import even the most basic staples.

Such a strategy may have worked a few years back, wherein one could borrow dollars at much cheaper interest rates, given close to zero interest rates in developed markets, but a global monetary contraction changed this dynamic.

Head in the sand

Ironically, policy makers remained aloof of whatever was happening globally, and continued to operate from a place of ignorance, pushing the country over the edge, while eroding savings and purchasing power of the vast majority of the country’s population. This was an act of economic sabotage that is unparalleled — or maybe one can see many such events happen every few years as the musical chairs of geriatric policy makers continue unabated.

To enable the appreciation of the Pak Rupee against the US dollar, the central bank started throwing money at the problem, further dwindling precious reserves.

To ensure that a fixed exchange rate continued, certain administrative measures were introduced which resulted in a reduction in imports, which ultimately lead to a severe disruption in the supply chain of goods across the board, whether it was a basic staple, or a good designated for exports.

As supply chains were disrupted, there was contraction in economic output, which in turn led to lower tax collections on a relative basis, as growth in tax collection could not even mimic inflation. A supply shortage further fuelled inflation which was already elevated due to the after-effects of the commodity supercycle.

The policy of an arbitrarily fixed exchange rate lasted for more than a few months, resulting in divergence between the exchange rate recognised by the central bank, such as the inter-bank rate, and the actual market rate, at which transactions were happening.

The spread between the hypothetical rate that the central bank kept close to its heart and published daily, and the actual rate at which transactions were happening was more than 15pc at one point.

This is potentially the highest spread between inter-bank rate, and open market rate that the economy has seen in this century. Due to such massive divergence, remittance flows were redirected to informal channels, which further dried up foreign currency inflows, resulting in more liquidity problems.

Read more: The fault in our Dar(s)

All this while, a coterie of rent-seeking supporters continued to support a fixed exchange rate, even though that spelled disaster for the economy.

As the economy readjusts to a new equilibrium exchange rate, fuel prices will be the first to incorporate the impact, followed by other imported goods, thereby further bumping up inflation.

Over the next few weeks, the second-round effects of inflation will start taking root, as goods that use fuel and other imported goods are also repriced, followed by an increase in wages in nominal terms to compensate for it all.

The upcoming inflationary spiral is going to push inflation to more than 30pc in the next few months, and may peak at just about the time when general elections are scheduled to be held. Decision making devoid of any data, and understanding of global macro trends, ought to end up in a disaster — as has happened in this case.

The gentleman obsessed with a fixed exchange rate proudly stated once that he had been at the forefront of many IMF programmes. Someone ought to tell him that there is no pride in this, and that they can add another feather to their cap, as Pakistan returns to the IMF yet again.

This won’t be the last time either, as we may need yet another programme, and a liquidity injection as soon as the new government takes charge.

The geriatric musical chairs don’t seem to be ending anytime soon, as we continue to work with prescriptions of the same people who have been at the helm of disastrous decisions over the last 30 years (or more).