Merits and Demerits of Devaluation

Merits and Demerits of De valuationBackground and HistoryPakistan has unusual history of successive devaluation. The rupee was first cheapen in 1950 in response to a similar move by India. Later in 1972, Z.A. Bhuttos regime massively libertine the rupee by 133%. The rupee was moreover de appraised in early 1980s during General Zia regime. Moeen Qureshis c artaker giving medication in 1993 as well devalued the rupee by 7%.After that it was Benazir Bhuttos government that further devalued the rupee and finally same measure ar cosmos taken by the present government of Prime Minister Mian Muhammad Nawaz Sharif.Pakistan has been on a corpse of managed float since January 8, 1982. For most of the past decade the rupee had been fixed in relation to the US dollar at the come out of Rs 9.9= US$1. The new put back regime commenced with an official nominal derogation of 5 percent in the month of January, and a cumulative 30 % for the year 1982. This was accompanied by the giving u p of the fixed peg to the US dollar and its replacement by a flexile basket peg whereby the authorities manage the nominal substitution rate actively. The stand in rate system has remained unlettered up to the present and the establishment has periodically re-affirmed its commitment to this flexible management in stabilization and adjustment programs negotiated with the IMF. Since the entre of the new system on that point has been a continuous down slide in our exchange rate. At present the rate of Pak RS in 2010. This represents a disparagement of 260 percent sinceDevaluation and its functionDepreciation or devaluation refers to the downward apparent motion of the rate at which the home bills exchanges against the contrasted currency or an amplify in the domesticated cost of wiz unit of the international currency. Depreciation is the name given to this drop when it occurs in a free market devaluation is the same social occasion resulting from government actions in a m arket that is not free. Since 1973 most of the currencies are on the floating currency system, through the system of dirty floating unperturbed al woefuls government/ central banks to interfere to some extent. The question of devaluing the external value of the currency is mavin of the hotly debated issues in humanity insurance discussions. On the one hand, the IMF and the World Bank supports devaluation as an important component of their recommended policy package for less developed countries (LDCs). On the former(a) hand m whatsoever economist and stinting policy makers are strongly opposed to devaluing currencies has become a dirty word in many countries.Technically, devaluation of a currency is the move resort when other fiscal and monetary measures like demand management , financial incentive, trade restrictions have proved to be less effective in solving puzzle of balance of payment, by boosting the pastorals exports and decreasing imports.In countries like Pakistan wher e major economic occupation is lack of growth, exports are get-go because of poor quality of goods quite a than the value of the currency. The mechanism of the open market keeps on adjusting exchange rate automatically and has made devaluation obsolete.Balancing MechanismBasically devaluation is a measure to correct a fundamental disequilibrium in countrys balance of payments. Equilibrium in a countrys balance is a result of restraint on imports and foreign payments of all sorts and an expansion of exports and foreign exchange earning of all sorts. The restraint on import cannot be achieved through appeals. It has to be through through direct restriction and/or through operating theater of the damage mechanism, that is to say through making imports costlier by operating on import duties, and this in fact has been extensively done in many growth countries, including Pakistan. However, this is open to some objections and limitations so a simple way of making imports costlier is n ot adjustment of the exchange rate. The entire burden of making imports costlier is not primarily placed on the exchange rate mechanism. It is shared by the device of import duties and also quantitative regulations. The import duty mechanism can also be used to make transition to the new exchange rate and to give a certain amount of discretionary treatment to individual items of import.The price FactorThe other major objective of devaluation is to promote export. It should be noted that what is contemplated is an increase in exports in foreign exchange in term of domestic currency. Exports on the whole exit have to increase by more than the percentage of devaluation. Expansion of exports depends upon a number of factors, the elasticity of supply in devaluing country and of demand for the outputs of that country abroad. Much depends on the prices at which the devaluing country is able to offer its goods.Contractionary ImpactReluctance to adjust the exchange rate in downward direc tion is due to its possible contractionary impact on output and employment, re-distribution of income from wages earner to property owners, cost-push inflationary pressure and the initial approbative effect on the balance of payment. All of the above forget eventually reserved through a process of domestic inflation and larger imports. When quantitative controls on imports duties are reduced along with the devaluation, imports and exports are not particularly sensitive to price changes especially in the short run. This is particularly applicable in the case of UDCs whose imports are often consist of essential capital goods, intermediate inputs including fuel and fertilizer and sometimes basic consumer goods like food grains, edible oils etc. There is exact scope for cutting down these imports. The exports of UDCs on the other hand mainly consist of primary commodities and processed materials whose supply elasticity are rather low in short run. If devaluation has to improve the ba lance of trade in short run, it should come through a reduction in the level of output and changes in the distribution of income towards high saver which would reduce the demand for imports and generate a bigger exportable surplus. Recession, unemployment and unequal distribution of income are the cost of a self-made devaluation.Inflationary PressureThe ineffective of exchange rate adjustment in securing improvement in the external balance primarily comes from the fact that changes in costs arising from exchange rate movements feed through quickly and extensively into the economy and contribution to the accerlation of prevailing inflationary pressure associated with an improvement of the monetary conditions. The rigid put on in price over a long period has stimulated defensive inflationary responses amoung industrialists, agriculturalist, business mens, and wage earner and has nullified the impact of exchange rate adjustments on the international competitiveness of our exports. I t should be taken into account that devaluation corrects the past inflationary and other economic development that led to adverse movement in the balance of payment. This does not protect the balance of payments against further inflationary and other adverse developments. Frequent devaluation of a currency is undesirable. It stimulates speculation and results in torment in income, consumption, industrial growth and public finance. This also erodes the confidence in the currency.DEMAND ManagementUnfortunately, for keeping our external accounts disequilibrium within sustainable limits, we have relied rather heavily on exchange rate adjustment and not paid attention to the efficiency dimension of our economic system. Economic efficiency at the large and micro levels requires high productivity, technological efficiency, high evaluate of saving and investment, and incomes policy that does not lead to cost-push inflation and fiscal-monetary policy that provides a stable environment for minute demand management. These are the simple and inflexible economic laws that were recognized and grasped. Neither nix controls nor artificial stimuli like frequent depreciation of external value of the currency with help except a little and temporarily.International trade and DevaluationGlobalization is the strategy of todays world. The concept of information sharing has reinforced the process of globalization passim the world. The consultant and analysts are, therefore, working on the integration of the entire system to run smoothly without any hindrances. Looking at the economic activity in this scenario, there is two major classifications, good and services. The globalization of goods can be seen in the prospective of international trade. By international trade we mean exchange of goods betwixt the nations. Looking at the economies of the world we find that the states are broadening their activities by offering investors to share their share of excellence and encouraging their local anesthetic manufacture to research the possibilities of selling their goods in the foreign markets. International trade is really important in terms of increase the foreign exchange of the country which ultimately prospers the people.The Government of Pakistan has liberalized its trade policy with devaluation of Pak rupee and encouraged the manufacturers to export their goods and invited foreign companies to compete in the local market.The key reason for international trade is provided by the system of Comparative costs importance of relative cost saving in the outturn of one item over the other. Obviously it would be better to corrupt a product from china at the price of Rs 1/= instead of producing it at the cost of Rs. 2/- that can be ultimately be interchange for Rs 2.50 in the market.There are various other reasons which strongly support the trading among the countries, few of which areDecreasing costConsumption of excess productionDifference in tasteForeign E xchange rateFrom international trade, we mean buying and selling the goods among nations. The deal cannot, of-course, be taken place without accessibility of currency to be accepted by the seller, on the other hand an exporter/importer would definitely like to know how the exchange rate of Pakistan rupee into dollar is being fixed, and how can her benefit from it?. At present in Pakistan we have managed float of currency to determine exchange rate as an independent policy instrument.We use up some criteria to fix the exchange of currency amoung the countries. It is important to note that only a favourable exchange can really benefits the nation and by favourable exchange, we mean, getting more foreign currency by paying less local currency. Theoretically there are two type of exchange ratesStable Exchange rateAltough stable exchange rate has no pratical value now a days, yet it helps in understanding the determination of exchange theory. A stable exchange rate was set by the value of gold. However, with passage of time, the limitation and deficiencies of gold standard blended emerging. Few of these were carrying inconvencies, remelting of gold, shipment of gold, different valuation of gold by different countries, and unavailability of sufficient gold to meet with the heavy demand. That is why the gold system was found inadequate ans was replaced with the flexible exchange rate.Flexible or floating exchange rateFlexible exchange rate is set by the interaction of demand and supply muniment for foreign exchange indepently. The optimum level in demand and supply teory is set at the point where supply equal to the demand. So if a person want to buy electric equipment from the States worth $ 100000/- and an American in contrast wants to buy cotton and the parity betwixt US$ and Pak rupee is 11, the equation leave be somehow similar to as followsDemand for US$ by Pakistan 100,000Demand for Rs. By America 50,000Pakistan is demanding more dollars than America wa nts to supply. The demand and supply are not in balance, consequently Pakistan shall have to refix the parity between $ and rupee at a level where our demand for $ will become equal to the supply of $. Now if we reduce the price of our goods by half of the existing priceDemand for US$ by Pakistan 100,000Demand of Rs by America 25,000This reduction price will have dual effectsDollas will become more expensive, the American goods will become more costly.Pakistani Rupee will become more cheaper, our goods will become cheaper and as a result the demand for our goods will increase.From the above it can be include that demans for imports should be in line with supply of exports. Total value of imports and exports of a country can also help manufacturers to design their plans for future expansion. With an expensive foreign currency, export may be increased with relatively low price supply of goods and quality production within the country. At the same time with a cheap currency investment can be made in foreign countries to utilize the cheap resources and ultimately increases the value of the firm.DEVALUATION its effects on ExportsAs the reason for the devaluation has been to strengthen the countrys balance of payment by stimulating exports, curtailing imports and by encouraging overseas Pakistanis to remit their earning through banks by narrowing the wedge between the official exchange rate and the kerb rate in the open market. It is universally accepted concept that the exchange rate mechanism is used to wee-wee a balance between the imports and exports but what is lesser known fact is that this mechanism need to be implemented at the overcompensate time and for the right economic reasons to be fully effective in achieving the desired purpose.Advantages and Disadvantages of DevaluationAdvantages of DevaluationDevaluation helps in obtaining international market demand perfection in quality and reduction in price up to a competitive level. As both developed and un derdeveloped countries function in one international market therefore, it is not motiveless for Pakistan to sell a product which is also produced by France, Germany or Holland if the prices are high. However, we are competing with the underdeveloped countries, it is, therefore, very necessary for us to adjust our prices with the prices of our competitors to serve in the market.Every new product has four stages, out of which the first stage is introduction stage. An introduction stage demands lot of efforts to promote the product and create sentiency among the buyers. At this stage it is vital to sell it at even below the cost. That is why the government provides certain duty drawbacks for a specified period, until that time when the product is self-sufficient.Each country maintains an account for its total imports exports schedule along with balance of payment chart. At times when its imports increase from its exports and the balance of payment deteriorates it becomes vital to inc rease its exports immediately. The reduction in prices is one of the quickest ways of increasing the exports.At times when people tend to buy imported goods and local industry start suffering, it is necessary to discourage the people so that they cut down their expenditure towards foreign buying and direct towards local goods. Devaluation is one of the techniques to reduction imports and encourage the local industry.Reduction in price through devaluation has long term effects, which can be seen over a period of time.All the above conditions are presently prevailing in Pakistan. However the question arises as to why all these conditions have comparatively more drastic affects on our economy. The answer to this question relates to our policy of income projection and receipt from foreign donors and countries. In the past, we were used to manage our budgetary gaps with the help of aids and debts. But this time the situation is different we could not did any foreign source of income. T he IMF was used to extend loans for our development programs in the past. However, during the current year the IMF had stopped its $300 million trench of its ESAF credit. The result is quite evident devaluation and imposition of new duties/taxesDisadvantages of DevaluationDevaluation with all its disadvantages has become an irregular policy. It is rater an ad-hoc arrangement for less demand. Instead imperfect planning is essential to forecast the future when the original price level will be maintained again.Devaluation involves high risk of inflation with the country for e.g if the exports do not increase as the result of decrease of price the country will suffer losses due to increase cost of all imports as well as local imports. Loss resulted due to decrease in prices in international market.Devaluation automatically increases the value of external debts and correspondingly the amount required for debt servicingDevaluation of a currency is considered as a last step to be taken af ter failure of all other fiscal and monetary measures.Before devaluing currency to boost economy through increasing exports, other factors need to be evaluated, for example, lower exports may be because of poor quality of goods, trade barrier, lower value added goods, unavailability of export items e.t.cContinued depreciation of currency may result in unlawful import of goods within the country. Such unlawful import and export may creat unlawful parallel economy within the country, which will be completely out of the control of the government.Devaluation is always supported by special incentive package to reduce the internally produced items for export.By critically analyzing all the above referred factors, it is proposed that the following necessary action should be taken to improve the situationTax Network should be enhanced bya) levying tax on agriculture,b) improving collection procedure,c) bringing small businessmen under tax nutshell etc.Imports should be discouraged by encour aging locally produced quality goods.Export of value added items should be increased instead of increase of low value exports to compete with the other developing countries.Needless to say that government should reduce drastically its own expenditure. It is vital for government to build up its creditability through investing money in public projects very honestly.The proceed from privatization of public sectors should be utilized to pay off our external as well as internal debts. Rescheduling of the debt should also be requested from the lenders.In case of our low priced items in the international market, we should prove that the reason of our low price quality items is not government support but cost efficiency. This can be done only with the help of very competent professional people i.e management accounts, engineers and managers.With the current devaluation, it is vital that necessary incentives must be given to industry and fixed income group for their survival and to reap the benefit of devaluation.The government should build capacity to deal with economics problems on both macro and micro level. It is generally believed that the government does not possess necessary capabilities, out of elected representative and bureaucrats to deal with it. That is why most of our key position holder is either current of Ex World Bank/IMF officials.It is also suggested that major businessmen and industrialist should be taken into confidence before any major decision.Effectiveness of price control committees very necessary. In countries like Pakistan where every individual has the power to determine the price of his own product, inflation is automatically multipliedConclusionsClearly, devaluation has not been the answer. It has rather contributed to a further increase in the trade gap. The important consequences of devaluation are the burden it is putting on the repayment of the foreign debts. The ensuing depletion of reserves has such a negative effect that the positi ve impact, if any, is more than wiped out by the increased foreign exchange burden.Reviewing the policy of devaluation by successive governments in the last 50 years, one finds that devaluation has miserably failed to resolve any problems or improve the macro or micro economic conditions in the country. Rather, devaluation has been counterproductive. In the existing scenario of the forces of demand and supply, the rupee is evaluate to continue with its downward trend. If the counter measures through cost cutting and efficiency management are not taken to check the inflation, which is already running in double digit, the advantages of devaluation will be offset as in the past, leaving adverse impacts as our economy which mainly depends on imported raw-materials, fuels and capital goods. That will certainly bring more hardships for common Pakistani people because our industry has substantial imported inputs in a wide range of locally produced goods and will also retard the process of industrialization in the country. Similarly defense budget and debt servicing will cost more due to costlier dollar.Our main problem is still uncontrolled i.e. the rise in non-development expenditures, which has given rise to the culture of living beyond means. This can be countered by adoption of practical rasping measures by the government especially at the top level to set the example for the whole nation.