Special Edition-07.pdf - Lahore School of Economics

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128 M. Ashraf Janjua will particularly pinpoint the magnitude if the exchange rate has deviated significantly from its equilibrium level. For this purpose, the paper is organized in the following way. The second section is about the history of exchange rate regimes and its significance for Pakistan’s external trade. The third section discusses the methodology used for assessing the deviation of the exchange rate from its equilibrium level. The fourth section pertains to concluding remarks. II. Exchange Rate Regimes and Pakistan Foreign Trade Pakistan pursued different exchange rate regimes in its history spreading over 60 years. Initially, the Pak rupee was pegged to the Pound Sterling. The Pak rupee was then pegged to the US dollar in 1971 and the new exchange rate parity was fixed at Rs.4.76 per US $. After the separation of erstwhile East Pakistan (now Bangladesh) in December 1971, Pakistan had problems in absorbing the surplus products which earlier used to be sent to former East Pakistan. Large amounts of raw cotton piled up during fiscal year 1971/72. Since its introduction on 15 th January 1959, the Export Bonus Scheme (EBS) had become increasingly complex with all the adverse consequences of multiple exchange rates for resource allocation. Also, Pakistan experienced a high rate of inflation during this period. These events convinced policy makers to rationalize the exchange rate through adjustment. As a result, the Rupee was depreciated on 11 th May, 1972 and the new exchange rate was set at Rs.11.00 per US Dollar. Pakistan's Foreign Trade and Rupee/$ Parity 50,000 70 Million US $ 40,000 30,000 20,000 10,000 0 FY79 FY81 FY83 FY85 FY87 FY89 Trade (LHS) FY91 FY93 FY95 FY97 Exchange rate FY99 FY01 FY03 FY05 FY07t 60 50 40 30 20 10 0 Rupees
Pakistan’s External Trade: Does Exchange Rate Misalignment Matter for Pakistan? 129 The new exchange rate was viewed by some people as excessive devaluation of the Rupee 39 . However, when the US$ was devalued by 10% in February 1973, the Pak Rupee, being linked with US$, automatically appreciated by 10% and the new exchange rate was the Pak Rupee 9.90 per US dollar. This exchange rate continued till 8 th January 1982, when the fixed exchange rate was discarded, and the State Bank of Pakistan adopted a managed float based on a basket of 16 currencies of Pakistan’s trade partners. Following the worldwide trend of deregulation of economies and exchange rates, Pakistan opted out of the fixed exchange rate regime and floated the value of the rupee against a basket of sixteen currencies under a managed exchange rate regime on 8 th January 1982. As a result, the value of the rupee depreciated quite significantly after the adoption of the managed floating regime. During the 1990s, the value of the rupee was generally set in line with the inflation differential. In other words, the rupee had to be devalued to offset the adverse effect of domestic inflation on the real exchange rate. For the last decade, however, exchange rate depreciation has been undertaken more as a desperate attempt to control the rising Current Account Deficit (CAD) than to follow the Purchasing Power Parity (PPP) rule. The cumulative current account deficit during the period 1992/98 stood at about US$23-30 billion which was financed by the entire amount of US$11.0 billion of foreign currency deposits besides government’s additional external borrowings. Accumulation of large shortterm liabilities in the absence of an equal rise in foreign exchange reserves was bound to lead to a crisis in a period of economic or political uncertainties. The economic crisis occurred when Pakistan exploded the nuclear bomb on May 28, 1998. During the fixed exchange rate regime from FY73-82, the actual Real Effective Exchange Rate (REER) moved in tandem with the price differential and the movement of the US Dollar vis-à-vis major currencies. The Rupee regained competitiveness in real terms during 1976–79, because of the continued lower inflation differential and US Dollar depreciation visà-vis major currencies. During the early 1980s, the REER appreciated substantially due to the appreciation of the US Dollar against major currencies and higher domestic inflation as compared to its trading partners. Keeping in view this sharp appreciation, Pakistan adopted the managed floating exchange rate system on January 8, 1982. The period thereafter was 39 For details of discussion among the policy makers which led to new exchange rate, please see Janjua, “The History of State Bank of Pakistan, Volume-III, (1977-88),” pp 409 – 413.
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11. All references used in the text
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The Lahore School of Economics The
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