Devaluation arguments for and

against
Introduction:
Appendix 9.2 includes 3 articles, 2 of these were written a few days
before 28 October 1995s devaluation, and one immediately after 12
September 1996s devaluation. These 3 articles examine the pros and
cons of devaluation, analyzing its impact on the economy. The following
section presents main summary of these 3 articles.
Theme of Articles:
Devaluation is a controversial topic for an economy. Some economists
speak in favor of it and others says it does not solve problems of an
economy, instead it adds fuel to fire and worsen the issues.
First few paragraphs are explaining the situation in country, how
various rumors and talks about the expected devaluation of Pak rupee
against US $. And the behavior of Bankers, Currency analysts,
Importers, SBP authorities, and Governors towards these rumors. A
brief trend of previous devaluation has also been discussed.
Most of the analysts gave some reasons, which explained why the
devaluation was mandatory. They say that there is a need for
devaluation because of the (1) continued widening of the trade gap, (2)
the fall in foreign exchange reserves, (3) and mounting inflationary
pressures. But the actual figures indicate that the trade and current
account deficits, for instance, have both been falling not over the last few
years, not widening. These two deficits are closely related with the
exchange rate, and there trend has been downward, which signals no
need for current devaluation. And foreign exchange reserves are also
rising since 1990 not falling, again devaluation is not required. Inflation
is the only reason on which analysts are right but for the wrong reasons.
High inflation in one trading country as compared to the other makes
the real exchange rate to deteriorate and creates a need to devalue the
nominal exchange rate. Because, Real Exchange Rate is the Nominal
Exchange Rate times Relative inflation; if inflation goes up, the nominal
exchange rate has to be adjusted to maintain the value of Real Exchange
Rate. Pakistans inflation rate is higher than its trading partners, but
devaluation on these grounds would only add fuel to the fire. Pakistans
inflation is currently around 14.8 and devaluation would prove to be
inflationary and further worsen an already bad price situation.
The main reason in favor of Devaluation is that it will make our exports
more competitive by bringing their prices down and it will ultimately
result in an increase in exports, and increased volume of foreign
exchange earnings. But many economic analysts think that exports may
not be price sensitive and they may b affected by non-price factors. And
if in case exports do increase, the price of imports will also rise at the
same time and for a country like Pakistan whose imports are greater
than its exports, it can be disastrous.
Some analysts gave another argument that the value of Indian rupee has
fallen, and this move is done by Indian govt. especially to discourage the
Pakistani export commodities in international markets. This claim is
illogical; firstly, because Indian goods are not directly comparable to
Pakistani exports and nor are they perfect substitutes, and secondly the
devaluation seen in Indian rupee was temporary, where rupee fell to 35
per dollar for only a short period and then again stabilized at around
33.80.
Most governments hate to devalue because in the short run there are
more losers than are gainers. Imports and locally produced import
substitutes become expensive after devaluation hence boosting the
inflation. And only a few exporters benefit from devaluation.
In Pakistan, Governor of State Bank sets the value of rupee in view of
supply and demand for other currencies, if he misreads the signal and
devalues the result is inflation and extra debt burden. And if he over
values the currency, it overvalues exports and undervalues imports,
resulting in a trade deficit. More reliable rates are domestic and
international inflation rates and the fiscal and trade deficits. Pakistans
inflation rate is high and its fiscal and trade deficits are increasing, trade
deficit has gone up to $3.5 billion, and reserves are already low. If in this
situation Pakistan borrows from international money lenders like IMF or
World Bank, they will demand heavy premium, which further increases
the debt burden.
So a justification in favor of devaluation is that, what a Governor needs
is a policy that reduces our expenditures and increases our earnings ad a
sizeable devaluation is such a policy measure. It sends a strong signal to
domestic buyers that imports are expensive so avoid them. And it sends
a message to foreign buyers that Pakistani exports are cheaper, come
and buy them. This brings down the trade deficit and releases the
pressure on reserves, and now Pakistan can borrow from IMF and
World Bank on low rates.
The third article provides solid evidence that there is no need for further
devaluation and there is no point in saying that Pakistani rupee is
currently overvalued. And Pakistans current account deficit is
consistent with the fact that being a developing country, we are net
importer of capital. The formula, relative price index divided by NEER is
a measure used for getting Real Effective Exchange Rate, and Pakistans
NEER is 405 and the Relative price index is 241 which suggest that
Pakistani rupee is already undervalued, so there is no need for further
devaluation.
Critical Analysis:
Devaluation always has some short run costs such as an increase in the
international debt burden and general reduction in the standard of
living. The real culprit in Pakistans case is high domestic inflation
which has raised the costs of production, including the high interest
rates.
My Point of View:
Yes after reading the 3 articles that devaluation has more demerits than
merits. And especially Pakistan who is net importer of capital,
devaluation will increase the prices of imported capital, required for
industry. Exports are already low, so inflation will further worsen the
situation by also increasing the prices of domestic import substitutes and
will boost the inflation.
Conclusion:
Conclusion after reading the above literature is that no devaluation is
required in developing country like Pakistan. Because many analysts
believe that exports are not only influenced by price but also heavily
influenced by non price factors, such as Quality and etc. so devaluation
will not result in increased exports and decreased imports, but it will
ultimately result in heavy inflation.