Gone are the days when there was stability in the movement of the rupee vis-a-vis the dollar.
The rupee value used to be stable till the 1980s. Financial globalisation brought volatility in the movement of the rupee. Pakistan followed the managed exchange rate regime for a long period of time and used to devalue the currency, as and when required.
The rupee-dollar parity remained at 60 for many years in the first decade of the 21st Century and that period could be described as the period of industrial stability and growth. Then pressure mounted on the government to devalue the rupee and the parity changed to 90 in a short span of time.
The one-off devaluation did surprise people. However, it did not provide opportunity to speculators to rule the roost.
The rupee-dollar parity remained at 105 for many years and it provided an opportunity to industrial capitalists to get benefit out of this stability. Industrial expansion and growth was witnessed during this period.
Then macroeconomists, analysts and international financial institutions came down hard on the government and declared the rupee overvalued and the parity touched 140 in 2017. Under the managed exchange rate regime, the rupee-dollar parity was maintained provided foreign exchange reserves were available in adequate amount.
Pakistan adopted the flexible exchange rate under the dictates of the International Monetary Fund (IMF) in 2019. Media commentators and analysts who believe in the free market system welcomed the move.
The usual argument is that market forces should determine the value of the rupee. Government intervention distorts the parity and paves the way for cheap imports.
The proponents of flexible exchange rate are of the view that it will orient the economy towards exports and aid in export promotion. To what extent this happened in the last four years is in front of us.
The flexible exchange rate is suitable for those countries which have large foreign exchange reserves. If there is any abrupt movement in the currency, the central bank can stabilise it by drawing down on the foreign exchange reserves.
On the contrary, the adoption of flexible exchange rate in a developing economy like Pakistan will pave the way for speculation.
Since the adoption of flexible exchange rate, the ups and downs in the rupee vis-a-vis the dollar have increased. Though the outgoing government put in maximum efforts to stem the devaluation, it had to succumb to financial globalisation, which has increased speculation in the currency.
If the rupee is weak, the speculators will become active to weaken it further. They will try to get maximum benefit out of its weakness. The speculators will buy dollars, which will further weaken the rupee.
When the speculators know that they are protected against loss in the presence of low dollar reserves in the coffers of the State Bank of Pakistan (SBP), they will buy dollars in large quantities. As a result, the rupee will slide vs the dollar.
If the rupee is stable, the speculators will have no ground for speculation. A frequently changing rupee-dollar parity will provide a breeding ground for speculation. The speculators anticipate that it will depreciate further so they will keep buying dollars or exchange rupees for dollars.
In a nutshell, the one-off devaluation will not provide any ground for speculation. On the contrary, frequent devaluation of the rupee will be a prelude to speculation in a world swamped by financial globalisation.
Last but not the least, frequent devaluation of the rupee will make future imbalances in the current account difficult to handle.
The writer has worked at SDSB, Lahore University of Management Sciences (LUMS)
Published in The Express Tribune, August 28th, 2023.
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