Printer Friendly

Pakistan's Foreign Exchange Rate and Control Regimes.

Byline: Dr Zafar Mahmood

This is first of the two articles on the exchange rate that I am contributing for the worthy readers of the Hilal. This article begins by explaining the exchange rate and then delves on to demarcate the evolution of Pakistan's exchange control regimes. The second article will provide reasons as to why Pakistan is currently experiencing volatility in its exchange rate.

Exchange rate is the price of a currency at which a country trades it for another country's currency, normally on the foreign exchange (forex) market. The foreign exchange market exists predominantly among large banks, domestic and foreign, and among foreign exchange companies. Exchange rate is usually determined in the forex market through the interaction of supply and demand arising from the forex market transactions. In reality, there are different rules under which a country's exchange rate is determined, especially the way the monetary or other government authorities intervene in the forex market or stay away from it. Broadly speaking, the exchange rate regimes include pegged or fixed exchange rate, managed floating exchange rate, and flexible exchange rate.

Pegged exchange rate is a regime in which the central bank announces an official (par value) of its currency and then maintains the actual market rate within a narrow band by intervening in the forex market.

Managed floating exchange rate is a regime in which exchange rate fluctuates on daily basis but the central bank attempts to influence the exchange rate by buying and selling currencies. It is also called a 'dirty float'. A floating or flexible exchange rate is a regime wherein a currency's value is allowed to fluctuate according to forex market. In this regime, the central bank does not intervene in the forex market to influence the exchange rate but it does not preclude the central bank to buy or sell foreign currencies for other purposes. With above understanding of the exchange rate, let us now turn to delineate different phases of the exchange rate regimes of Pakistan.

Fixed Exchange Rate Regime (1947-1981): After independence in 1947, Pakistan linked its currency to the Pound Sterling; this link was maintained till 1971. In 1949, the UK government devalued the Pound Sterling and India followed it by devaluing its Rupee. Both of them pressurised Pakistan to devalue its Rupee. Pakistan was one of their major suppliers of raw materials and a buyer of their finished products. Pakistan, however, took its sovereign decision not to devalue its currency at that time. Pakistan took this decision because devaluation of its currency would have meant our imported plants and machinery becoming expensive to our industries, while given a small export base there was no guarantee that exports earnings will increase. Later on it turned out to be right decision because it not only supported our industrialisation drive but it also enabled Pakistan to diversify its export markets.

Up to August 1955, the rupee-dollar exchange rate was maintained at 3.31 rupees per US dollar. After the Korean War boom there was a global recession and the world economies including Pakistan faced the problem of scarcity of the foreign exchange reserves. Consequently, Pakistan had to devalue its currency in 1955. The new rate was fixed at 4.76 rupees per US dollar; that is, the rupee was devalued by 30 %.This devaluation enabled Pakistan to realise a growth rate of 44.4% in just one year.

With the increase of economic influence of the USA, Pakistan pegged its currency to the US dollar on 17th September 1971 but the exchange rate of Pakistan with US dollar was kept fixed at Rs.4.76 per US dollar. By the end of the 1960s, Pakistan was implementing a very complex system of controls and multiple exchange rates owing to export bonus voucher scheme. To come out of the clutches of this system, Pakistan opted to devalue its currency and abolishing the prevailing schemes of export promotion. It devalued its currency by 58% and the new exchange rate was set at Rs. 11 per US dollar on 11th May 1972.

Pak rupee appreciated by 11% in February 1973 after the devaluation of US dollar by 10%. As the rupee was pegged to US dollar, Pakistan had to revalue its currency to Rs.9.90 per Us dollar. This exchange rate continued till 7th January 1982. With rising domestic inflation, large fiscal deficit and decline in remittances, the rupee once again became overvalued, especially after the appreciation of the US dollar to which the currency was pegged. To overcome this problem Pakistan abandoned the fixed exchange rate with US dollar and float the rupee under managed exchange rate regime by delinking its currency with dollar and linking it with the currencies of 16 major trading partners following the worldwide trend of deregulation of economies and exchange rates. The exchange rate adjustment allowed Pakistan to experience an export growth rate of 26.8% per annum during this period.

Managed Floating Exchange Rate (1982-1998): The government fine-tuned the over-valuation of the currency by adopting the managed floating exchange rate on 8thJanuary 1982 and linking the currency to a basket of currencies of its major trading partners. The value of the currency started declining after the adoption of the new exchange rate regime.

Since 1991, some new measures to reform the exchange and payments system were introduced that include: (i) resident Pakistanis were allowed to maintain foreign currency accounts like non-residents to attract funds held abroad by private citizens, legally or illegally; (ii) restrictions on holding of foreign currency and on foreign exchange allowances for travel were removed; and (iii) rules governing private sector's foreign borrowing were liberalised, especially where no government guarantee was required. In addition, host of other restrictions on foreign payments were removed (e.g., for the purpose of education, royalty payment, foreign advertisement, and professional institutions' membership).

In 1994, full convertibility of Pak rupee was introduced for current account transactions as part of the trade liberalisation programme, while for the capital account convertibility a cautious approach was adopted. The central bank implemented partial convertibility of the capital account by allowing foreign exchange companies to operate in Pakistan and the corporate sector to obtain foreign equity. Pak rupee was also made fully convertible for some capital account transactions, e.g., foreign portfolio investment in the country. Aside from allowing 100 % foreign equity participation, no restrictions were in place on the repatriation of capital, profits, royalty, etc. With all of these measures, Pakistan was able to achieve an annual growth rate of 8% during this period.

Multiple Exchange Rate and Dirty Float Regimes (July 1998-July 2000): This phase was marked with political instability in the country and economic sanctions by western countries as a result of the nuclear test by Pakistan. The government froze the foreign currency accounts in order to preserve its official foreign exchange reserves. These circumstances eroded the confidence of the private sector. Whatever liberalisation achieved on current and capital accounts in the earlier periods was virtually reversed. To counter the crisis, government adopted the system of multiple exchange rates consisting of an official rate (pegged to US dollar), a Floating Inter-Bank Rate (FIBR), and a composite rate (combining official and FIBR rates). During May 1999, Pakistan adopted the system of dirty floating exchange rate and the currency was pegged to the US dollar by removing the multiple exchange rate system. The exchange rate was then defended within narrow bands (margins) till July 2000.

Because of the events of this short period, Pakistan faced an annual decline in exports at the rate of -0.34%. Flexible Exchange Rate Regime (July 2000-2009): Since 20th July 2000, Pakistan de jure is following a flexible exchange rate regime. Nevertheless, the de facto exchange rate arrangement has managed to float without fixing pre-determined paths for the exchange rate. The central bank's interventions are limited to moderating and preventing excessive fluctuations in the exchange rate. The central bank intervenes in the market using the US dollar. Foreign exchange controls and restrictions are now minimal.

Current account transactions are now unrestricted except for occasionally imposed limits on advance payments for some imports. Foreign investors can now freely bring in and take out their capital, profits, dividends, royalties, etc. IMF (2010) classifies Pakistan's exchange rate regime as a de facto conventional peg to the US dollar within a narrow band. During this period exports grew by 8.8% per annum.
COPYRIGHT 2013 Asianet-Pakistan
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2013 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Geographic Code:9PAKI
Date:Oct 30, 2013
Previous Article:The Six Dimensions of National Security.

Terms of use | Privacy policy | Copyright © 2019 Farlex, Inc. | Feedback | For webmasters