The Causes of Pak Rupee Devaluation

During the month of May’08 Pakistan Inter-bank and Kerb forex markets
witnessed a sharp decline in Pak Rupee value versus US$. Despite the Central
Bank’s intervention and some regulatory steps, Pak Rupee continuously losing
its value. Under a floating FX rate system, the exchange rate decline is
expected & a necessary component of the adjustment mechanism.

There are so many factors that cause currency crises to occur, i.e. economic,
political, corruption, etc., but to determine the route causes of current crises,
let us focus only on the major economic variables, these variables are
interlinked with each other, therefore, it cant be sure that which one triggers
the other:

a) Price shocks (Includes decline in Export commodities prices or

inclined in Import commodities prices) One of the major and most
discussed cause of current crises is the ever-rising price of imported
crude oil, which hit close to a record $127 a barrel on May 15 and an
all-time high of $128 a barrel the next day amid widespread fears
over stretched global energy supplies.

b) Expansionary fiscal or monetary policies adopted by the

previous government in order to stimulate the economy, and which
cause aggregate demand to grow at a pace higher than domestic
supply. The gap between aggregate demand and domestic supply is
filled by imports. The result is that imports grow more quickly than
exports. Current account deficit goes up, which has to be financed
through either falling foreign exchange reserves or capital inflows.
Capital inflows, however, may not be forthcoming because of lack of
trust in the country’s financial situation.

c) Fiscal deficit, previous Government resorts to borrowing from the

central bank or from foreigners to meet huge PSDP expenditures.
Borrowing from the central bank increased the inflation. High inflation
is proved lethal for export, because it distorts prices. In particular,
inflation increases the input cost of exportable goods and makes
them less price competitive.

As far as foreign liabilities are concerned, Pakistan total external

liabilities surged to $45.822 billion by the end of March 2008,
compared to $42.882 billion on December 31, 2007. Although former
Prime Minister Shaukat Aziz and his team of ministers claimed that
their government had broken the begging bowl, figures of the State
Bank of Pakistan (SBP) showed a different picture. Five years ago on
June 30, 2003, total external liabilities of the country stood at
$35.439 billion. The break-up of figures shows that public and
publicly-guaranteed debt increased to $40.479 billion by March 31,
2008, which was $37.836 billion on December 31, 2007
d) Weaknesses of domestic financial system also contribute to the
eruption of a crisis. Foreign capital plays an important role in
economic development. However, in many cases capital inflows have
been volatile. Increased capital flows have been followed abruptly by
equally massive capital outflows. Countries with weak and un-
transparent financial system are particularly vulnerable to this
problem, as happened in case of the Pakistan. The massive foreign
home remittance inflow after 9/11, abruptly over stimulate the
Equity, Real Estate and essential/luxury commodities markets, in fact
our financial system and economic managers has failed to utilize
massive inflows into capital and capacity building spending.

e) Capital flight, low Foreign Direct and Portfolio Investments

are another major contributors of current crises, it is also clearly
witnessed by KSE tumble. Foreign investors preferred pulling their
liquidity out of the market due to the prevailing political and
economic landscape. This capital outflow will result a fall in SCRA
(Special Convertible Rupee Account). Foreign Direct Investment in
Pakistan during July-April 2007-08 dipped by 16.7 per cent year-on-
year to $3.48 billion and portfolio investment by 93.3 per cent to
$119.4 million as compared to the corresponding period of the
previous fiscal year

f) Speculative Pressure, in emerging markets like Pakistan

speculation always remains the major factor behind an exceptional
behavior. In current crises the speculative factor was further
aggravated by the lack of availability of US$ at local Kerb market.
Some banks on the other hand engaged in excessive trading
activities, that create undue panic, and they also encourage their
export clients to delay the realization of their remittances. According
to the State Bank of Pakistan, the country’s total liquid foreign
reserves further declined by $48.7 million during the first 10 days of
May, 2008, to $12.207 billion on May 10. Thus, foreign exchange
reserves have now declined by $4.293 billion from $16.50 billion less
than a year ago.

g) The Real Exchange Rate: Real FX rate = The relative price of two
identical baskets of goods in the two countries. Increase in the real
exchange rate creates currency devaluation pressures, because it
hurts all firms that are exposed to foreign competition. Exporters
suffer, because their costs are higher when measured in terms of
foreign currency. Firms facing import competition are hurt, because
foreign producers are under no pressure to increase prices with
domestic inflation. The impact of an increase in the Real Exchange
Rate depends to a great degree on the Trade to GDP ratio, an
appreciation of the Real Exchange Rate of a country with a high Trade
 to GDP ratio is particularly worrisome because exports are not
competitive in world markets, and imports capture a greater market
share in the domestic market.

By considering the density and the consequences of current Pak Rupee

devaluation crises, it could not graded as a similar or much bigger then, 1997
South East Asian Countries Crises, 1998 Russian Rubble crises or 1994
Mexican peso crisis.

Some, experts firmly believes that it’s a speculative pressure which may not
go too far, due to some upcoming major influx of US$ into domestic market,
and rupee should eventually stabilize around Pak Rupee 65-66/US$ bend.

* Budgetary support from ADB, China and KSA $ 1.45

Billion
* Budgetary support from UK, Japan & GCC Countries $ 1.00
Billion
* Lucky Cement GDR $ 0.109
Billion
* MCB Bank’s Stack sale to Malaysia’s Maybank $
0.674 Billion