MM News TV
Tuesday 27th September 2022 / 1 Rabiulawal 1444

Politicized Dollarization

The term dollarization is shorthand for the use of any foreign currency by another country. Dollarization occurs when residents of a country extensively use foreign currency alongside or instead of domestic currency. Dollarization is a situation when the local currency loses its stability as a medium of exchange due to hyperinflation or instability and the same is happening in Pakistan. Most developing countries as well as transitional economies just adopting market mechanisms already have a limited, unofficial form of dollarization. To a greater or lesser degree, their residents already hold foreign currency and foreign currency denominated deposits at domestic banks. In high inflation countries, dollars or some other hard currency may be in widespread use in daily transactions, alongside the local currency. Since the end of the Bretton Woods system of fixed exchange rates, the old dilemma facing countries of finding workable currency exchange arrangements has become more challenging, and the choices have become more varied.

The decision about which exchange rate system to adopt has become more difficult as world trade and capital markets have become more integrated. New problems have emerged, and with them, new answers to the question of the best exchange regime to promote each countrys development objectives.

The season of rate hikes and policy tightening is in full swing around the globe. Pakistan is not only country in the region going through political turmoil. Traditionally, each independent nation had its own currency as a symbol of sovereignty, but in a globalizing world national currencies have been weakening or even disappearing. The US dollar has been taking over as the worlds currency of account. Neo-liberal open markets and rapid currency conversion have reinforced the dollar’s role since the mid-1970s. Much trade is now dollar-based, countries prefer to hold their central bank reserves in US dollars, and private companies as well as wealthy citizens often hold dollars or dollar-denominated assets. The United States derives great economic and political power from this dollar hegemony. During the 1990s, dollarization accelerated. A number of countries pegged their currencies to the dollar or even adopted the dollar outright as their national currency, hoping that this would solve inflation problems.

Pakistan cannot afford a “dollarized” economy, therefore, the government should control dollar flight without any further delay. Reducing inflation and giving relief to the people was one of the major promises of the PDM while campaigning against the PTI government. Once in power, it can either try to provide relief Rajapaksa style, by putting Pakistan’s macroeconomic stability at stake, or remain prudent and take some non-popular measures, backing out from its promises. However, the latter option would expose it to the wrath of the PTI, which in opposition would be pretty lethal. Unofficial dollarization has existed in many countries for years. It has attracted much study by economists, but far less political attention because it is to a certain extent beyond the control of governments. Dollarization has been in the news lately because of interest in official dollarization.

The rupee has plunged to 236.12 Pakistani Rupee against the dollar in the inter-bank market. Since the industry heavily relies on the import of raw material, components and machinery, this devaluation has highly increased the cost of production. The government should take all possible measures to strengthen the rupee with renewed focus on import substitution and enhancing exports, besides creating an environment of political stability. The rupee downturn is not due to economic fundamentals. The panic is primarily due to political turmoil. Emerging-market

currencies are feeling the heat as the hawkish Federal Reserve lures capital towards the United States. The panic in the South Asian market also comes from escalating risks after former premier Imran Khan’s by-election win added to concern over the country’s bailout deal with the IMF, which it needs to avoid a default. The recent movement in the rupee is a feature of a market-determined exchange rate system. Pakistan is grappling with fast depleting foreign currency reserves, a declining rupee and widening fiscal and current account deficits, and the rupee has lost 20% of its value since December 2021.

Pakistan has also passed through another bout of political instability, with the government of Prime Minister Shehbaz Sharif taking over from then-premier Imran Khan, who was removed in April. Khan has been pressing the current government to call early elections, holding a series of political gatherings across the country. The recent decision by the State Bank of Pakistan (SBP) to hike the benchmark interest rate by 150 basis points to an 11-year high of 13.75% is wielding a mixed impact. On a positive note, the decision is in-line with the market expectations predicted by expert economists. Thus, the markets have already adapted to the announcement – avoiding consequent volatility. Moreover, the rate hike is a central step to harness inflation – spiking to a 30-month high of 13.8% in May. Nonetheless, the SBP has increased the policy rate cumulatively by 675 basis points since September 2021. Still, inflation has lingered in double figures – climbing from 11.5% in November to 13.4% in April. While it is premature to claim that a hawkish policy is radically the searing inflationary pressure in Pakistan is mainly due to the geopolitical tensions in Europe. The Russian invasion and the retaliatory sanctions from the West have riled the global commodity markets. Russia and Ukraine (combined) account for almost 30% of the global wheat supply. The Ukrainian seaports in the Black Sea currently blockaded by Russian forces are crucial to worldwide exports, futile, tightening interest rates is not enough to grapple with the existing economic woes.

Demand-side policies are casting a contrarian effect on the economic stability of Pakistan. Unlike the United States, Pakistan is a developing economy that thrives on growing consumption, investment, and industrialization. Additionally, the high policy rate continues denting the government budget due to heavy domestic borrowing. Almost 75% of commercial deposits have been lent to the government of Pakistan via recurrent auctions of T-bills and Pakistan Investment Bonds (PIBs). In the long run, supply-side reforms are the need of the hour. Currency swaps with China could hedge Pakistan’s sensitivity to sharp movements in the US dollar. National oil refineries should be upgraded to enhance their throughput and reduce the burden on the import bill. Meanwhile, the policy rate should get lowered to allow the export-oriented industries to grow and mitigate trade imbalance. Ultimately – sensible, independent, and complimenting monetary and fiscal policies are pivotal to channel Pakistan through the choppy waters of uncertainty currently upending the global economy.

Do you want to read authentic news from Pakistan & across the world? So download MM News App Now !
Back to top
Exit mobile version