IMF & Pakistan: Impact of Rupee Devaluation on Economy

Since the new Government of Tehreek-e-Insaaf came to Power after General elections in July 2018, there has been a change in the socio-economic and political policy framework and Pakistan’s stand as Prime Imran Khan has now again said through social media and even in his speech at multiple event that “interest of Pakistan and is people shall be supreme under all circumstances”.
Keeping that of view Pakistan is facing issues on many of its front, one the most important and critical front is its economic front, where Pakistan urgently needs to bail out itself on the upcoming loan instalments and Pakistan is at a crucial point of decision making regarding their financial aspects that are going to affect its future economic decisions.

So the main question at this critical time is up-to Tehreek-e-Insaf Government to decide that: Are we likely to relapse into the fold of yet another burdensome and economically disastrous program? In truth, our relationship with the IMF has been a long and uncomfortable one. Loans from the Fund continue to be the gift that keeps on giving, even if at times we do not want it, and certainly regardless of whether or not we are in the position to return it.

Since 1988, Pakistan has entered into 12 different programs with the IMF, which by contrast, is greater than all countries in the region combined. India till now has signed only 1 contract with the Fund, while countries such as Nepal and Bangladesh have signed a mere 2.
The total amount owed to IMF by the countries around the world, 10 biggest borrowing countries, including Portugal, Greece, Ukraine, Ireland and Pakistan, owed $72.4 billion, or nearly 86% of the total amount lent across the globe (bussinesstandard.com, 2018).

Pakistan, for this very reason, was classified as a ‘prolonged user’ by the IMF in 2002, ranking third in the world, higher than every low-income African nation, but surpassing the two countries, Philippines and Panama.
One reason for this most certainly has been our constant and very costly effort to keep at par with India, militarily, as well as our long-standing war on terror, all of this done too in the face of exceptionally low levels of savings in the country as Pakistan is unable to maintain current account surplus since decades.
As a result of such expenditures, our external accounts have typically remained under pressure, which along with the soaring costs of commercial borrowing from international markets, made the IMF was an easy solution to our problems.
Pakistan unfortunately for the programs we have signed on, we have been unable to complete the majority of them, thereby abandoning them halfway and have up till now only successfully completed a total of 4 programs over the last two decades.

Pakistan has been under several IMF programs since the last two decades, Pakistan’s economy has faced many blows. No loan comes without a price, and in IMF’s case, this meant we were obligated to implement a series of poorly designed organizational programs, which has plunged the economy in an abyss drowning the country in the restrictions and constraints imposed by IMF.

Under the Fund, we saw dramatic reductions in subsidies, overall public spending on critical areas such as health and education, as well as a wage freeze and a ban on employment in the public sector for the sake of severity and fiscal alliance. In a country such as ours, where the government is the largest employer, this undoubtedly had serious adverse effects. As a result of such policies, we saw a fall in investment and growth rates, while unemployment, poverty and inequality rose.

It is no secret that IMF’s working model is seriously flawed, and has far-reaching consequences for economies. Most programs are ‘self-serving’ in nature, aimed to help the Fund retrieve their money rather than fix the economy of the borrowing country.
In fact, judged on its mission that it emphasizes as its primary task-at-hand that is to ‘promote high employment and sustainable economic growth, and reduce poverty around the world’, the IMF is an utter failure.
The Fund has lent billions of dollars to developing nations since its formation, but such loans have in fact hurt their clients and reduced economic opportunities, instead of promoting growth, loans from the Fund and other multilateral institutions have left the citizens of borrowing  nations heavily burdened with enormous debts and, as a result, deprived them of meaningful economic opportunities.

Its ineffectiveness in maintaining economic stability and growth and many accuse the Fund of being a tool of the United States foreign policy, advancing the country’s strategic and economic interests.
Being the only nation with an outright veto helps the US to sway decisions to its benefit, which are often taken not on the basis of strong economic motives, but rather political ones. This can be plainly grasped in our own relationship with the Fund, whose pockets are generous to us during times when Pakistan’s position is favorable with the West and tightfisted otherwise.

By far the best example of this has been post 9/11, when we were handed a very large-hearted loan package as a compensation for joining America’s war on terror.
Keeping all this in perspective, our past and on-going turbulent relationship with IMF and its implications on Pakistan’s socio-economic fabric, Asad Umar’s pledge comes days after Pakistan’s central bank warned inflation could double in the coming year hitting 7.5% while the country’s growth target rate of 6.2% would likely be missed.

The announcement from the government about again, engaging with IMF for the 13th program has created an air of discontentment in people for the Government, as it makes the people wary of the implications that are to be faced when Pakistan’s take help from the Fund.
Pakistan has witnessed various rounds of depreciation this year, which resulted in the decline in value of the rupee vs. the dollar; this supposedly should have resulted in an increase in exports and a decline in the trade deficit. Although exports have picked up, the country witnessed it’s a highest-ever trade deficit in recent times, putting Pakistan to a disadvantaged end of the bargain, when it comes to import and export.

All this seems paradoxical, isn’t it? However, the concept and theory of J curve can help us understand this situation.

According to this theory, a country’s trade deficit increases immediately after currency depreciation. The reason behind this is the fact that contracts for the past several months have already been negotiated by the trading parties.
Hence, the price competitiveness of exports resulting from the depreciation doesn’t increase immediately. Furthermore, the buyers may have negotiated some long-term contracts with exporters in other countries and it is not possible for them to switch to more price-competitive exports immediately.

Similarly, on the import side after currency depreciation, the import bill initially increases. The consumers also alter their buying decisions with a lag and they take time and due consideration in moving from more expensive imports to local substitutes and this change will occur only if local substitutes of imported goods are available.

All this seems paradoxical, isn’t it? However, the concept and theory of J curve can help us understand this situation.
According to this theory, a country’s trade deficit increases immediately after currency depreciation. The reason behind this is the fact that contracts for the past several months have already been negotiated by the trading parties.

Hence, the price competitiveness of exports resulting from the depreciation doesn’t increase immediately. Furthermore, the buyers may have negotiated some long-term contracts with exporters in other countries and it is not possible for them to switch to more price-competitive exports immediately.

However, according to the J curve theory, the deficit will decline over time when export orders will be renegotiated by our buyers and local consumers will shift consumption from imported goods to local substitutes.
This devaluation of our competitors has made ours relatively weak in making exports more price-competitive (Express Tribune, 2018)

Although this J curve mechanism has seldom worked in our history, let’s hope it works this time.
Another thing that is new this time around is slightly novel. It is not only Pakistan that has witnessed such rounds of depreciation. Our competitors like India and Turkey have also gone through such episodes with their currencies also at all-time lows.

Implications of Devaluation on Pakistan’s Economy:

Unfavorable terms of trade

Another long-term issue with perpetual deficits relates to the unfavorable terms of trade for all developing countries.
Prices of goods that developing countries like Pakistan exports i.e. textiles, commodities, etc. have been on a declining trajectory in the past. On the other hand, goods and services exported by the developed world like cars have become relatively more expensive over time.
Furthermore, these luxury items are becoming more expensive and less durable over time. Previously, cars were bought for a lifetime, now it is necessary to replace old ones within a five-year time period.

Inflation

Devaluation is likely to cause inflation because, Imports will be more expensive (any imported good or raw material will increase in price), and Aggregate Demand (AD) increases – causing demand-pull inflation.

Travel abroad is expensive

Devaluation of currency reduces the purchasing power of citizens abroad, e.g. it is more expensive to go on holiday abroad.
This situation calls for a creative and curious solution, to conclude, while ending our dependency on the IMF may be far-fetched, one thing remains clear; future programs with the Fund, if any, must be negotiated bearing in mind the needs and interests of our own people and economy.
Furthermore, it is well time for the IMF, along with other Breton Wood Institutions, to change their outlook on the economics of lending and abandon the damaging cookie-cutter approach to which they cling on so dearly and to some extent look out for economic betterment of the country they are giving a loan to considering the sustainable development goals and strengthening the country’s economic structure and policies to improve their chances for a better future.