VCheng
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We all know how such manipulations come to an end.
Rupee devaluation in Pakistan? Currency drops most in 9 years
- Thread starter Ryuzaki
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We all know how such manipulations come to an end.
-22% return in the stock market would freak out money managers
VCheng
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The longer the presently overdue adjustment is delayed, the more painful it will be.
instant gratification is the name of the game
VCheng
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VCheng
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A good read:
http://www.thefridaytimes.com/tft/chronicle-of-a-devaluation-foretold/
Chronicle of a devaluation foretold
Assad Ahmad
It is no secret that our government continues to manipulate currency markets to fix the value of the rupee vs. the dollar at an artificially strong level. Left to its own devices, as it will soon be, it would swiftly depreciate.
The IMF estimates the rupee may be overvalued by up to 20%—implying that if freely determined, it would be near 125 per dollar. Other lenders, investors, economists and former central bankers (including one sacked for this view) all know this, differing only on the degree. They worry that the longer this imbalance persists, the more difficult the inevitable adjustment will be. Even the government knows this. If it didn’t, or if it weren’t true, it wouldn’t need a policy to maintain the status quo. It would maintain itself—the market would buy and sell dollars for 105.40 all day without the government raising a finger.
But there is a policy. So who benefits from it? What are the costs? Why is the government persisting with it? And how does it all end?
An overvalued rupee provides short-run benefits to millions of people in an import-oriented economy such as Pakistan’s. If the government fixes the dollar at Rs105, when it should be Rs130, almost everything people buy (cars, petrol, tea…) is cheaper than it should be. Inflation rates end up being lower than they would be otherwise (we are experiencing record low rates). Effectively, an overvalued exchange rate is a subsidy for imports, and who doesn’t like that?
Except, there is no such thing as a free lunch.
Maintaining an overvalued exchange rate has real costs. Imagine a farmer, Chaudhry Ilyas, selling onions in his village for Rs105 a kilo while the price in nearby villages is Rs130. Chaudhry saheb is mobbed by buyers and runs out of onions. In the real world, Chaudhry saheb would raise his price. But what if he wants his village to enjoy cheap onions? He can persist with his pricing policy, and borrow money to buy onions for Rs130 and sell at Rs105. Or he can borrow onions to sell for Rs105. But effectively he is paying a 25-rupee subsidy per kilo, with borrowed money and borrowed onions. And, as a result, no matter how much he tries to minimize his losses by convincing people to buy other vegetables instead, people will buy a lot more onions than they would otherwise.
Replace Chaudhry Ilyas with the government, onions with dollars, and you have the present problem with our economy: the rigid defence of an overvalued exchange rate, resulting in an untargeted subsidy for domestic consumers, at a rapidly rising cost, funded by borrowed money. This is the essence of Daronomics.
Demand for dollars depends on demand for the things dollars can buy. For us, this means imports. Governments can act to reduce foreign currency outflows and increase inflows by reducing import demand (through tariffs for e.g.), and trying to increase exports, foreign investment, remittances and aid. Whatever gaps in dollar supply and demand remain, are made up for by changes in reserves and borrowing/lending.
It is widely accepted that when exchange rates float freely, the market can help automatically balance these gaps by weakening the currency (and making imports less attractive) when foreign currency outflows exceed inflows, and vice versa. The strong rupee policy has slammed this door shut.
These gaps help explain what the strong rupee policy has cost. And to be clear, the costs, paid for with foreign currency borrowing, will be paid back, with interest, by the Pakistani taxpayer.
To illustrate, let’s take a simplified, round-number look at what central bankers call the “external position” and how it has evolved over the past few years.
In 2014-15, imports outstripped exports by $20.2b. We had $4.6b of financial outflows (debt servicing and profit repatriation), $22b of “secondary income”, mainly workers remittances, that shrunk the dollar demand gap to $2.8b—our current account deficit for the year. Foreign investment almost equalled this, leaving no gap that needed to be financed by borrowing. Dollar reserves were low to start the year, so we incurred about $4.5b of debt to increase them.
On the surface, a decent year. Just below though, trouble was brewing. Despite a 30% drop in the average price of our main import, petroleum, our import bill barely moved. And while the dollar rose 22% against the US’s trade partners, the rupee hardly budged. This was as a result of policy; it was not a market-determined price.
So, the government, primarily Finance Minister Ishaq Dar, saw the price of onions rising in other villages throughout 2014-15, but refused to let their price rise. Surely, they couldn’t have missed the fact that the Euro, the currency of Pakistan’s largest trading partner after China, fell 30% vs. the rupee from its peak in early 2014 till mid-2015.
We began 2015/2016 with an exchange rate that had just appreciated massively against those of our trade partners and competitors. Oil was another 40% cheaper, saving us $4b. Despite this, imports remained unchanged. Exports, much pricier now in foreign countries, fell. Imports exceeded exports by $22.7b. Outflows were $5.3b and secondary income (mainly remittances) $23.1b, leaving a current account deficit of $5b.
Simply put, people were lining up to buy Mr. Dar’s onions. Portfolio investors, always averse to overvalued currencies, began pulling the plug, going from huge net buyers in the prior year, to net sellers of $330m. FDI, a bright spot, brought in $2b, driven by CPEC. These flows left a dollar demand gap of $3.5b. Yet amazingly, reserves didn’t fall, and the currency didn’t weaken. In fact, magically, reserves grew again, by almost the same amount as the last year: $4.5b. How? Nearly $7b of fresh foreign currency borrowing. So Mr. Dar, pleased at the demand for his onions (cheap dollars), not only didn’t raise his price (weaken the rupee), he borrowed more onions. Chaudhry Ilyas would be proud.
By 2016-17, the onion buyers were whipped up into a frenzy that even Mr. Dar couldn’t keep up with. Imports surged $7b. The largest driver wasn’t machinery, as the government claims. It was petroleum, with imports up $2.5b. Almost every group of imports contributed to the boom. Imports of food, machinery, vehicles, textiles, and even “other products”, all grew by at least $700m each. In short, we saw a textbook case of an import-led, debt-financed consumption boom, enabled by an inappropriate fixed exchange rate.
With exports falling slightly again, the chasm between imports and exports grew to an astonishing $30b, 50% more than just two years ago. With remittances and outflows broadly unchanged, the current account deficit surged to $12b. Portfolio investment was again negative, with concerns over currency overvaluation as a driving factor. After FDI, we were left with a dollar demand gap of $10.7b. The borrowing went into overdrive, clocking up $9b, with commercial banks getting in on the act, and reserves declined $1.7b. They have since continued to fall, at an increasing pace.
The sidelining of Mr. Dar hasn’t changed anything. The new PM has categorically stated that devaluation is “not on the table”, further exposing the pretence of a market-determined exchange rate.
So, while exporters and potential exporters are getting hit by an overvalued currency, the real cost has yet to come. It will be borne by everyone, in the form of debt repayments, with interest. The worst part is, the currency will devalue one way or another, most likely in a sudden shock. Ganday vee khadday tay chhitar vee khaday.
Clearly borrowing $10b a year to finance imports isn’t going to be manageable for long. So why is the government doing this?
What government, with an uninformed electorate, wouldn’t do something that it doesn’t have to pay for now, but which allows its vote-bank to enjoy an elevated standard of living for a few years? It is a blunt instrument with no control to ensure that only the poor benefit. But, while it lasts, it creates a sense of prosperity that can be helpful at election time.
Secondly, as politicians, they are more concerned with creating an impression of macroeconomic stability, than attaining it. For the layman, the fact that the dollar rate is broadly the same as it was when they took over, seems like success. That is the reason for the dollar obsession, as opposed to any focus on effective exchange rates.
So how does it all end? Not well. The government has been making noises about tariffs on imports and other impractical trivialities but in reality, the plan is likely to stay the course till elections. Another international bond issuance is in the works, and other borrowing will continue. There is a chance that this plan will not succeed, and reserves may decline so rapidly that they will no longer be able to control a disorderly devaluation.
If they do succeed till then, there are two probable scenarios, assuming they win the election. (If they don’t it’s not their problem.) Most likely, shortly after the election, they will allow the currency to devalue. They could also influence the caretaker government to do this and take the blame.
The less likely scenario is that they will keep the currency fixed, and continue to borrow until they can, which won’t be for long. This will take them to the IMF for a bailout, the likely condition of which will be a severe devaluation (perhaps 30-40%, that should have happened over years). Egypt had to devalue its currency 48% last year in one go, to qualify for funding.
In short, it’s been fun, but the party is coming to an end. But while it’s still on, do swing by – onions and dollars for Rs105 – a steal if there ever was one.
The writer is a Lahore-based columnist and consultant. He has served as a director in the global markets division of a major European investment bank. He tweets @assadahmad. The views expressed here are his own.
==========================================
When this devaluation happens, do I get to say "I told you so"?
http://www.thefridaytimes.com/tft/chronicle-of-a-devaluation-foretold/
Chronicle of a devaluation foretold
Assad Ahmad
It is no secret that our government continues to manipulate currency markets to fix the value of the rupee vs. the dollar at an artificially strong level. Left to its own devices, as it will soon be, it would swiftly depreciate.
The IMF estimates the rupee may be overvalued by up to 20%—implying that if freely determined, it would be near 125 per dollar. Other lenders, investors, economists and former central bankers (including one sacked for this view) all know this, differing only on the degree. They worry that the longer this imbalance persists, the more difficult the inevitable adjustment will be. Even the government knows this. If it didn’t, or if it weren’t true, it wouldn’t need a policy to maintain the status quo. It would maintain itself—the market would buy and sell dollars for 105.40 all day without the government raising a finger.
But there is a policy. So who benefits from it? What are the costs? Why is the government persisting with it? And how does it all end?
An overvalued rupee provides short-run benefits to millions of people in an import-oriented economy such as Pakistan’s. If the government fixes the dollar at Rs105, when it should be Rs130, almost everything people buy (cars, petrol, tea…) is cheaper than it should be. Inflation rates end up being lower than they would be otherwise (we are experiencing record low rates). Effectively, an overvalued exchange rate is a subsidy for imports, and who doesn’t like that?
Except, there is no such thing as a free lunch.
Maintaining an overvalued exchange rate has real costs. Imagine a farmer, Chaudhry Ilyas, selling onions in his village for Rs105 a kilo while the price in nearby villages is Rs130. Chaudhry saheb is mobbed by buyers and runs out of onions. In the real world, Chaudhry saheb would raise his price. But what if he wants his village to enjoy cheap onions? He can persist with his pricing policy, and borrow money to buy onions for Rs130 and sell at Rs105. Or he can borrow onions to sell for Rs105. But effectively he is paying a 25-rupee subsidy per kilo, with borrowed money and borrowed onions. And, as a result, no matter how much he tries to minimize his losses by convincing people to buy other vegetables instead, people will buy a lot more onions than they would otherwise.
Replace Chaudhry Ilyas with the government, onions with dollars, and you have the present problem with our economy: the rigid defence of an overvalued exchange rate, resulting in an untargeted subsidy for domestic consumers, at a rapidly rising cost, funded by borrowed money. This is the essence of Daronomics.
Demand for dollars depends on demand for the things dollars can buy. For us, this means imports. Governments can act to reduce foreign currency outflows and increase inflows by reducing import demand (through tariffs for e.g.), and trying to increase exports, foreign investment, remittances and aid. Whatever gaps in dollar supply and demand remain, are made up for by changes in reserves and borrowing/lending.
It is widely accepted that when exchange rates float freely, the market can help automatically balance these gaps by weakening the currency (and making imports less attractive) when foreign currency outflows exceed inflows, and vice versa. The strong rupee policy has slammed this door shut.
These gaps help explain what the strong rupee policy has cost. And to be clear, the costs, paid for with foreign currency borrowing, will be paid back, with interest, by the Pakistani taxpayer.
To illustrate, let’s take a simplified, round-number look at what central bankers call the “external position” and how it has evolved over the past few years.
In 2014-15, imports outstripped exports by $20.2b. We had $4.6b of financial outflows (debt servicing and profit repatriation), $22b of “secondary income”, mainly workers remittances, that shrunk the dollar demand gap to $2.8b—our current account deficit for the year. Foreign investment almost equalled this, leaving no gap that needed to be financed by borrowing. Dollar reserves were low to start the year, so we incurred about $4.5b of debt to increase them.
On the surface, a decent year. Just below though, trouble was brewing. Despite a 30% drop in the average price of our main import, petroleum, our import bill barely moved. And while the dollar rose 22% against the US’s trade partners, the rupee hardly budged. This was as a result of policy; it was not a market-determined price.
So, the government, primarily Finance Minister Ishaq Dar, saw the price of onions rising in other villages throughout 2014-15, but refused to let their price rise. Surely, they couldn’t have missed the fact that the Euro, the currency of Pakistan’s largest trading partner after China, fell 30% vs. the rupee from its peak in early 2014 till mid-2015.
We began 2015/2016 with an exchange rate that had just appreciated massively against those of our trade partners and competitors. Oil was another 40% cheaper, saving us $4b. Despite this, imports remained unchanged. Exports, much pricier now in foreign countries, fell. Imports exceeded exports by $22.7b. Outflows were $5.3b and secondary income (mainly remittances) $23.1b, leaving a current account deficit of $5b.
Simply put, people were lining up to buy Mr. Dar’s onions. Portfolio investors, always averse to overvalued currencies, began pulling the plug, going from huge net buyers in the prior year, to net sellers of $330m. FDI, a bright spot, brought in $2b, driven by CPEC. These flows left a dollar demand gap of $3.5b. Yet amazingly, reserves didn’t fall, and the currency didn’t weaken. In fact, magically, reserves grew again, by almost the same amount as the last year: $4.5b. How? Nearly $7b of fresh foreign currency borrowing. So Mr. Dar, pleased at the demand for his onions (cheap dollars), not only didn’t raise his price (weaken the rupee), he borrowed more onions. Chaudhry Ilyas would be proud.
By 2016-17, the onion buyers were whipped up into a frenzy that even Mr. Dar couldn’t keep up with. Imports surged $7b. The largest driver wasn’t machinery, as the government claims. It was petroleum, with imports up $2.5b. Almost every group of imports contributed to the boom. Imports of food, machinery, vehicles, textiles, and even “other products”, all grew by at least $700m each. In short, we saw a textbook case of an import-led, debt-financed consumption boom, enabled by an inappropriate fixed exchange rate.
With exports falling slightly again, the chasm between imports and exports grew to an astonishing $30b, 50% more than just two years ago. With remittances and outflows broadly unchanged, the current account deficit surged to $12b. Portfolio investment was again negative, with concerns over currency overvaluation as a driving factor. After FDI, we were left with a dollar demand gap of $10.7b. The borrowing went into overdrive, clocking up $9b, with commercial banks getting in on the act, and reserves declined $1.7b. They have since continued to fall, at an increasing pace.
The sidelining of Mr. Dar hasn’t changed anything. The new PM has categorically stated that devaluation is “not on the table”, further exposing the pretence of a market-determined exchange rate.
So, while exporters and potential exporters are getting hit by an overvalued currency, the real cost has yet to come. It will be borne by everyone, in the form of debt repayments, with interest. The worst part is, the currency will devalue one way or another, most likely in a sudden shock. Ganday vee khadday tay chhitar vee khaday.
Clearly borrowing $10b a year to finance imports isn’t going to be manageable for long. So why is the government doing this?
What government, with an uninformed electorate, wouldn’t do something that it doesn’t have to pay for now, but which allows its vote-bank to enjoy an elevated standard of living for a few years? It is a blunt instrument with no control to ensure that only the poor benefit. But, while it lasts, it creates a sense of prosperity that can be helpful at election time.
Secondly, as politicians, they are more concerned with creating an impression of macroeconomic stability, than attaining it. For the layman, the fact that the dollar rate is broadly the same as it was when they took over, seems like success. That is the reason for the dollar obsession, as opposed to any focus on effective exchange rates.
So how does it all end? Not well. The government has been making noises about tariffs on imports and other impractical trivialities but in reality, the plan is likely to stay the course till elections. Another international bond issuance is in the works, and other borrowing will continue. There is a chance that this plan will not succeed, and reserves may decline so rapidly that they will no longer be able to control a disorderly devaluation.
If they do succeed till then, there are two probable scenarios, assuming they win the election. (If they don’t it’s not their problem.) Most likely, shortly after the election, they will allow the currency to devalue. They could also influence the caretaker government to do this and take the blame.
The less likely scenario is that they will keep the currency fixed, and continue to borrow until they can, which won’t be for long. This will take them to the IMF for a bailout, the likely condition of which will be a severe devaluation (perhaps 30-40%, that should have happened over years). Egypt had to devalue its currency 48% last year in one go, to qualify for funding.
In short, it’s been fun, but the party is coming to an end. But while it’s still on, do swing by – onions and dollars for Rs105 – a steal if there ever was one.
The writer is a Lahore-based columnist and consultant. He has served as a director in the global markets division of a major European investment bank. He tweets @assadahmad. The views expressed here are his own.
==========================================
When this devaluation happens, do I get to say "I told you so"?
you are reading too much into these arm chair economist from our eastern side. currency goest up and down as dollar strenghtes or weakens.
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