Is it a mere coincidence that the rupee is ‘largely stable’ and economic growth is gradually picking up? Or is it that a rising/stable national currency is better suited at times for economic growth in emerging markets?

A study — by two experts at the Bank for International Settlements (BIS) — that assessed the impact of exchange rate movements on trade, and financial channels on growth, supports the latter.

In their study on “Does the financial channel (price and availability of credit) of exchange rates offset the trade channel (exports and imports)?”, Jonathan Kearns and Nikhil Patel of BIS, observe “While the trade channel indicates that an exchange rate depreciation will stimulate domestic economic activity, the financial channel can have the opposite effect. …..that the financial channel partly offsets the trade channel for emerging market economies and the offset is weaker for advanced economies.”

While providing incentive to exports, the rupee depreciation has, to a large extent, obviated the need for improving productivity and quality

They looked at a sample of 44 countries, half of them emerging markets.

The rupee has depreciated against the dollar at a much slower pace during four fiscal years ending June 2015-06. From a 5-year peak at 9.98pc in fiscal year 2012, its value against the greenback fell merely by 2.79pc at the end June 2016.

To quote the State Bank of Pakistan’s annual report 2015-16, “Pakistan’s exchange rate market remained largely stable in FY2016”…despite depreciation of regional currencies including those of India , Sri Lanka and Pakistan in August 2015.” And “real GDP growth reached an 8-year high of 4.7pc despite global headwinds”.

In Pakistan’s case, rapid industrialisation in the 1960s was fuelled by a strong rupee through a multiple exchange rate mechanism. This kept the cost of imported capital goods and industrial inputs cheaper and more affordable for industrial investment.

A sharp depreciation of the rupee in the early 1970s turned many dollar-indebted industrial units sick, owing to a jump in heavy debt servicing burden. Since then the rupee has been sliding against the dollar in a bid to boost export earnings to service the country’s rising debt and to manage the current account and fiscal deficits.

With massive depreciation of the rupee over decades, there has been a huge transfer of resources abroad with more goods sold and less products imported for the same one dollar.

While providing incentive to exports, the rupee depreciation has, to a large extent, obviated the need for improving productivity and quality in order to make goods globally price-wise competitive.

While imports have not been curbed, they have not led to any meaningful import substitution either. The general trend, as witnessed in FY2016, is that while exports fail to meet the set targets, imports exceed them. The only major support to the growing trade gap is workers’ remittances, which many now fear have started to become stagnant.

The pressure thus built on the fiscal and balance of payments position, is managed by a heavy reliance on foreign debt or declining financial and capital inflows. The level of foreign investment is falling behind the repatriation of profits and dividends.

And the overall debt servicing cost for dollar and rupee borrowings, along with non-development expenses, is prohibitive. Islamabad now wants the provinces to provide funds from their constitutional share to finance some of the federal responsibility since it does not have enough funds to finance physical and social development or security needs.

In the situation that Pakistan is placed, the rupee depreciation tends to slow down economic growth. As researchers at the BIS have shown, currency depreciation in emerging markets has sometimes not proven to be much of a boon as rising currency can stimulate, and a falling currency can suppress, economic growth.

But the risk to the relative stability of the rupee has not gone away. In fact the threat is mounting.

The current account deficit has nearly doubled to $2.60bn during July-November 2016 against $1.36bn in the same period last year.

If C/A deficit keeps rising at this pace for the whole of the current fiscal year, it will deplete foreign exchange reserves and make foreign debt servicing difficult.

Pakistan has just successfully completed the IMF programme, though with liberal waivers granted by the Fund; but macroeconomic stability — for which growth was so subdued— is as elusive as ever.

Stability comes from strong fundamentals of the economy which continue to remain weak because IMF programmes do not go beyond fire fighting.

So far Pakistan has resisted both domestic and IMF pressure for sharp depreciation of the rupee. But if Islamabad is forced to go to the IMF for a bailout next year, its bargaining position may not be strong.

The risk of a faster slide of the rupee and its possible impact on growth cannot be completely ruled out

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