Any assessment of impact of depreciation must account for two counterfactuals. One, what would have been the situation of exports, imports, trade and current account deficits if rupee was held at the 2017 value? Two, what would have been the gains from depreciation if rupee was allowed to adjust before the balance of payment crisis?

The current government is being criticised by many for letting the rupee depreciate from Rs 122.79 per US dollar in end of July 2018 to Rs 164.84 by end of September 2020. In July 2016, the rupee had traded at 104.68 per US dollar. By and large, the PML-N government is credited with keeping the rupee largely stable during the 2013-2018 period. Other things being equal, a strong rupee keeps the external debt obligation from increasing too quickly.

Conversely, a depreciation of the rupee increases the so-called debt burden. Those opposed to depreciation point out that this does not significantly improve the volume of. While much can be said to explain low gains from depreciation in Pakistan, a couple of points are worth highlighting here.

Currency depreciation in Pakistan has always been “involuntary”. The authorities did not let the currency depreciate when an adjustment was due. The rupee was overvalued for a long time. Historically it has slipped only when the authorities were unable to control the supply of dollars any longer. Public debt has soared as a result; the foreign exchange reserves have been depleted. A strong rupee has also caused the trade and current account deficits to grow.

Under these conditions, the gains form depreciation are hard to come by. The sudden plunges in the value of the rupee cause panic, further compromising the gains. The impact of depreciation on foreign trade and related sectors depends on three broad factors. One, inflation in other countries particularly main trading partners; two, domestic prices; and three, overall macroeconomic conditions and policies, particularly during the depreciation phase.

The first two factors determine the real effective exchange rate (REER) and thereby external competitiveness. A higher external competitiveness leads to higher gains. The size of gains depends on the nature of exports and imports and the capacity to export. The third factor determines the extent to which depreciation will help boost the economic activity (thus enhancing the capacity to export). If any of these factors is missing, the potential gains from depreciation may be compromised.

Rising inflation in the domestic economy or lower inflation in other countries can hamper the transmission of nominal adjustment in currency to REER. Pakistan did not let the rupee depreciate in 2015-2017 when inflation was low. Even a small depreciation of rupee then could have effectively lowered the REER.

The damage (in terms of low exports) was done before the rupee started sliding in 2018. Net reserves with the State Bank of Pakistan had already started depleting, dropping from more than $18 billion in 2015-16 to $9.76 billion in 2017-18 and to $7,285.2 in 2018-19. According to SBP data total forex in the country dropped from $23 billion in 2015-16 to approximately $14.5 billion in 2018-19.

The balance of payment problem then started getting out of control. The economic conditions started worsening. The country then moved to contractionary policies. Headline inflation stood at 6.2pc in December 2018, compared to 4.6pc in the same month in 2017. Core inflation (trimmed) on year-on-year stood at 6.9pc in December 2018, as compared to 4.7pc during the corresponding month of the previous year. Subsequently, inflation rose beyond 14pc (in 2020). (Evidence suggests that depreciation is weakly linked to inflation in Pakistan.)

In order to control the inflation and attract the foreign capital to manage the forex holding, the interest rate was raised. It increased from 6.5 percent in May 2018 to 13.25 in July 2019 and stood there till March 17, 2020, before a reversal caused by Covid-19. While it was already following the priors, the government started implementing stabilisation policies - cut subsidies, increase energy/petroleum prices, practice austerity, increase interest rate - under the IMF Extended Fund Facility (EEF) after July 2019.

Any assessment of impact of depreciation on exports, imports and employment must consider the overall state of economy and policies. It must account for two counterfactuals. One, what would have been the situation of exports, imports, trade and current account deficits if rupee was held at the 2017 value? Two, what would have been the gains from depreciation if rupee was allowed to adjust before the balance of payment crisis? 

Overall, the GDP growth rate dropped form 5.48pc in FY2018 to 1.9pc in FY2019. The slowdown in economic activity, higher inflation, the decade-high interest rate (of 13.25pc) coupled with the rise in energy prices led to a higher cost of production which compromised the gains from involuntary depreciation. Large-scale manufacturing continued to shrink. The high interest rate limited the chances for the private sector to trigger economic expansion or increase investment.

The economic meltdown and the rising cost of production outweighed the gains from depreciation. Data from the SBP show that total exports of goods and services in FY2020 stood at $27,847 million compared to $30,619 million in FY2018 and 30,223 in FY2019. In other words, FY20 had lower exports despite depreciation. This, however, must be seen in context of the factors highlighted above.

While the economic meltdown and policies to cut the trade and current account deficits aggressively played a major part, depreciation too contributed to curtailing the imports. The SBP, in its State of Pakistan’s Economy Report of 2018-19, noted that depreciation was the key explanation for the 10pc decline in imports (which fell to $54.8 billion in FY19, after recording an increase of 14.9 pc in FY18). Imports substantially declined from $67.948 billion in FY2018 to $50.684 billion in FY2020.

According to the report, the travel services imports declined by $719.6 million, reflecting an increased travelling cost due to the depreciation. The report also states that imports of home appliances and related components, classified under electrical machinery, declined, as impact of depreciation was passed on to the customers.

Despite the significant drop in unit value of exports in 2019 and 2020 due to depreciation of rupee, Pakistan could not gain much in term of increasing exports. The decline in trade and current account deficit was mainly supported by contraction in imports. It is because of this that no significant impact of depreciation on employment and poverty was observed. The fault does not lie with depreciation. The adverse impact of the factors highlighted above outpaced the potential gains from the depreciation.

Any assessment of impact of depreciation on exports, imports and employment must consider the overall state of economy and policies. It must account for two counterfactuals. One, what would have been the situation of exports, imports, trade and current account deficits if rupee was held at the 2017 value? Two, what would have been the gains from depreciation if rupee was allowed to adjust before the balance of payment crisis?

The writer is a Research Fellow and heads the Policy Solutions Lab at Sustainable Development Policy Institute (SDPI), Islamabad. He tweets at @sajidaminjaved. The opinions in this article do not reflect the SDPI position happen?