CHANGES in exchange rates can greatly impact various parts of the economy. Balance of trade and exchange rate directly affect each other. A fall in the exchange rates will cause foreigners to buy more of our goods and us to buy less foreign goods. So, theory tells us that when the value of the Pakistani Rupee falls relative to other currencies, Pakistan should enjoy a smaller trade deficit. If we look at the country’s balance of trade data, this doesn’t seem to be happening. Is there any way we can reconcile the fact that the trade deficit is not decreasing with the fact that Pakistani Rupee has been greatly devalued? Since Pakistan’s massive trade deficit relative to the size of the economy has been a major cause of concern for the last couple of years, therefore, it is pertinent to look into the causes and solutions to this problem. Economics literature tells us that a depreciated currency will promote export. However, it depends on what percentage of Gross Domestic Product (GDP) is offered for foreign trade and what portion is sold in domestic market. If a substantial portion of the GDP is offered for international trade, then a fall in currency value will have a major impact on country’s balance of trade. In case of Pakistan, a very low portion of the GDP is traded internationally.
Currency devaluation also means a lower purchasing possibility of imported goods by local population. At the same time, the value of exports in domestic currency will grow but not necessarily in foreign currency. This is what happens in Pakistan. Value of domestic goods rise in terms of Rupee, but it remains the same in terms of US Dollar. Goods for export may also differ from goods for domestic consumption. Consider the case when oil is exported but food is imported. Russia has devalued its currency in the time of low oil price in 2014. Dollar income of population had already dropped, and the price of imported goods went up. Dollar price of domestic goods went down. Russia was unable to substantially increase oil production, so as a result the value of exports went down causing economic crisis. A concept known as Marshall-Lerner conditions can be related to Pakistani context. It states that a currency devaluation will only lead to an improvement in the balance of trade if there is higher demand elasticity for imports and exports, i.e. if demand for these products varies greatly with the change in their prices. In other words, domestic consumers will buy fewer imports and foreign consumers will buy more of our exports. In Pakistan, this is usually not the case. Since a certain section of society consume majority of imported products and these people can afford these products even if their prices go up. The richer the society, the more it buys. The poorer, the less. As for as our exports are concerned, we have only a few major trading partners. Trade deals with these countries along with the politics involved, our imports do not respond greatly to changes in their prices.
It also depends on country’s structure of production, existing capacity, speed of adjustment. Even if the demand for Pakistani products increase in international markets due to their low prices, the country does not have the capacity to fulfil that demand. Foreign and domestic investors reluctance to invest in domestic industries, energy crisis, poor law and order situation and several other hindrances will make the competitive advantage futile. Our economy also needs to import raw material, machinery and technology to increase exports which also makes the effects of devaluation minimal, especially when our economy is dependent on borrowed finances. A weaker currency will boost exports, which in turn will increase employment and this, as a result, will improve the economic growth but it can be said that depreciation is not a long-lasting approach to improve the economy. If the value of Pak-Rupee against the US Dollar decreases; it has a positive impact on the exports of the country.
This helps to temporarily boost up the exports of the country. While due to the decrease in the value of Pak Rupee, the imports become dearer and expensive for the country which adversely affects the balance of payment position of the country. What we need to increase exports is to increase production which depends on availability of human capital and physical capital. Due to slow adjustment, despite increase in world demand for exports the country will be unable to meet demand. The effect of devaluation may be positive or negative depending on the output response to price. In addition, in presence of restrictions such as quota, some countries are unable to reap the benefits. The effect of currency devaluation on exports also depends on world economy. If the global economy is in recession, then a devaluation may be insufficient to boost export demand. If growth is strong, then there will be a greater increase in demand. However, in a boom, a devaluation is likely to exacerbate inflation. If we do not take into account all, we may lead to wrong conclusion.
—The writer is freelance columnist.