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The Causes of Pak Rupee Devaluation

The Causes of Pak Rupee Devaluation

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Published by Asad Mehmood

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Categories:Business/Law, Finance
Published by: Asad Mehmood on Jul 10, 2009
Copyright:Traditional Copyright: All rights reserved

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05/10/2013

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The Causes of Pak Rupee Devaluation
During the month of May’08 Pakistan Inter-bank and Kerb forex marketswitnessed a sharp decline in Pak Rupee value versus US$. Despite the CentralBank’s intervention and some regulatory steps, Pak Rupee continuously losingits value. Under a floating FX rate system, the exchange rate decline isexpected & 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 areinterlinked with each other, therefore, it cant be sure that which one triggersthe other:
a)
Price shocks
(Includes decline in Export commodities prices orinclined in Import commodities prices) One of the major and mostdiscussed cause of current crises is the ever-rising price of importedcrude oil, which hit close to a record $127 a barrel on May 15 and anall-time high of $128 a barrel the next day amid widespread fearsover stretched global energy supplies.
 b)
Expansionary fiscal or monetary policies
adopted by theprevious government in order to stimulate the economy, and whichcause aggregate demand to grow at a pace higher than domesticsupply. The gap between aggregate demand and domestic supply isfilled by imports. The result is that imports grow more quickly thanexports. Current account deficit goes up, which has to be financedthrough 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 thecentral bank or from foreigners to meet huge PSDP expenditures.Borrowing from the central bank increased the inflation. High inflationis proved lethal for export, because it distorts prices. In particular,inflation increases the input cost of exportable goods and makesthem less price competitive.As far as foreign liabilities are concerned, Pakistan total externalliabilities surged to $45.822 billion by the end of March 2008,compared to $42.882 billion on December 31, 2007. Although formerPrime Minister Shaukat Aziz and his team of ministers claimed thattheir government had broken the begging bowl, figures of the StateBank 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 andpublicly-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 theeruption of a crisis. Foreign capital plays an important role ineconomic development. However, in many cases capital inflows havebeen volatile. Increased capital flows have been followed abruptly byequally massive capital outflows. Countries with weak and un-transparent financial system are particularly vulnerable to thisproblem, as happened in case of the Pakistan. The massive foreignhome remittance inflow after 9/11, abruptly over stimulate theEquity, Real Estate and essential/luxury commodities markets, in factour financial system and economic managers has failed to utilizemassive inflows into capital and capacity building spending.
e)
Capital flight, low Foreign Direct and Portfolio Investmentsare
another major contributors of current crises, it is also clearlywitnessed by KSE tumble. Foreign investors preferred pulling theirliquidity out of the market due to the prevailing political andeconomic landscape. This capital outflow will result a fall in SCRA(Special Convertible Rupee Account). Foreign Direct Investment inPakistan 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$119.4 million as compared to the corresponding period of theprevious fiscal year
f)
Speculative Pressure
, in emerging markets like Pakistanspeculation always remains the major factor behind an exceptionalbehavior. In current crises the speculative factor was furtheraggravated by the lack of availability of US$ at local Kerb market.Some banks on the other hand engaged in excessive tradingactivities, that create undue panic, and they also encourage theirexport clients to delay the realization of their remittances. Accordingto the State Bank of Pakistan, the country’s total liquid foreignreserves further declined by $48.7 million during the first 10 days of May, 2008, to $12.207 billion on May 10. Thus, foreign exchangereserves have now declined by $4.293 billion from $16.50 billion lessthan a year ago.
g)
The Real Exchange Rate:
Real FX rate = The relative price of twoidentical baskets of goods in the two countries. Increase in the realexchange rate creates currency devaluation pressures, because ithurts all firms that are exposed to foreign competition. Exporterssuffer, because their costs are higher when measured in terms of foreign currency. Firms facing import competition are hurt, becauseforeign producers are under no pressure to increase prices withdomestic inflation. The impact of an increase in the Real ExchangeRate depends to a great degree on the Trade to GDP ratio, anappreciation of the Real Exchange Rate of a country with a high Trade

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Ali Hassan added this note
nice information but i can read some of more information on another site. High unemployment, Negative balance of Payment. war against terror some of the biggest problem to devaluation of currency of Pakistan.Dollar price increase dramatically. http://talib.pk/article/48-reasons-fo...
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Ramsha Sundus added this note
wow its great and the information is very useful thnkx for uploading it :)
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