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Rupee, Dollar and Gold

Published on 1st Apr, Edition 14, 2013

 

Stable foreign currency exchange rate and foreign currency reserves are one of the critical aspects for Pakistan’s ability to engage in commerce with other countries. Volatility in the exchange rate is increasingly being recognized as a concern for Pakistan’s economy. The Pak rupee has depreciated significantly against the US dollar marking a new risk for Pakistan’s economy. After maintaining a range bound movement from 2009 to 2011, the rupee has registered depreciation against dollar since 2011 sharply. As a matter of fact, rupee depreciated almost 63 percent from 2008 to 2012, from 60 to 98 per dollar. Till the beginning of the fiscal year 2008, very few had expected rupee to depreciate while most hinting towards either appreciation or status quo in the rupee level. The question being raised is whether this sliding trend will ever be reversed or has the volatility come to stay in this market? Looking forward, it may be gauged that market participants expect little reversal in this trend of rupee depreciation. Those few who had even anticipated may not have imagined the scale of depreciation with rupee touching a new low every second month. What is even more interesting to note is that when other countries are trying to play currency wars and trying to keep their currencies devalued, Pakistan is trying to prevent depreciation of rupee.

Furthermore, Government of Pakistan has a budget deficit problem and has issues in borrowing money from both abroad and private sector. As Pakistan continues to experience deficits in trade and budget, the country is aided significantly by the international community. In recent months, Pakistan’s forex reserves have deleted sharply due to various factors whereas Pak rupee is not being accepted abroad with the depleting foreign currency reserves, hence the only option left to the country is to borrow funds from IMF. Now most of the donor agencies and governments have also expressed their displeasure on the condition of bad state of economy. As the currency is not stable and getting loans in US dollar further puts pressure on the currency. Hence, there is a significant downward pressure on the value of the rupee from the international market besides its depleting foreign reserves that basically originates the currency fluctuations.

Pakistan, being a developing economy, it is rightly expected that it would import more than it exports. Pakistan’s balance of payment is negative, which means the sum of current account and capital account with other countries is not in favor of Pakistan, whereas both current account and capital account play a role in determining the movement of the currency. Despite various attempts to obtain a positive trade balance, Pakistan has a consistent deficit in its balance of payments. Pakistan being the deficit country; also needs capital flows in the country, which is also decreasing year after year. In past, current account deficit was managed by the capital inflows but in last few years FDI has also decreased, which has put more pressure on rupee. With contribution of exporters remaining on the sidelines and earnings continuing to decline, a further widening of the current account deficit would result in outflow of dollars from the Pakistan’s economy accentuating the depreciation in rupee.

Another main driver of rupee depreciation has been the withdrawal of funds by the foreign investors from the domestic economy. The rather pessimistic view of foreign investors is being governed by the global developments. The ongoing eurozone debt crisis seems to be intensifying and rescue packages have been of limited assistance in truly resolving the crisis. The scenario in the US does not provide an upbeat picture either. Domestic macro-economic prospects as well are weighed by high inflation and slow industrial production, leads to downward revision of growth estimates to just below 3 percent for FY13. Consequently, foreign investors have withdrawn funds from Pakistan and invested back in the dollar, which has been strengthening.

 

Pak rupee depreciation naturally manifests in higher import costs for the domestic economy. Rupee will further depreciate assuming current level of both imports and exports and current account deficit. Moreover, there are higher chances that the domestic economy could be faced with a problem of higher inflation through imports. Commodities prices that are internationally denominated in US dollars would naturally priced higher on the back of a stronger dollar.

As downbeat forces played stronger over the last few months, investor risk-appetite has also contracted, thereby increasing the demand for safe haven such as investment in gold and silver. A weaker rupee usually encourages increase in gold prices. This is because investors choose to buy gold with the hope that gold can protect the value of their assets. Market participants are shifting from money market investment to gold investment, causing the demand for gold jumped so sharply. Recession like situation in Pakistan has also influenced the gold prices in the country. Current economic situation leads to high inflation so the benefit of using gold as a hedging tool against inflation is being felt by the people. With gold, people get a perfect protection against the decline in their purchasing power.

During the last two years since gold has come on the commodity market, there has been continuous upsurge in the prices, which has added to the woes of gold dealers as well as for the customers. Investors diversify their investments by including gold to maintain a stable portfolio. The commodity offers a strong hedge against falling interest rates, uncertain economic conditions, currency devaluation and losses incurred on other investments. Gold gave a mind boggling 897 percent return to investors over the last ten years. Its price increased from Rs6,280 per tola in 2002 to Rs62,600 per tola in 2012. Both gold market and forex market are concerned by the investors, because they have a relatively perfect, just, fair environment and more investment opportunities. There is a very close relationship between the two markets. However, the gold market and forex market are unpredictable with benefits and risks in Pakistan. The price volatility of gold market and forex market is affected by the same factors, such as political situation, terrorism and unrest. In worldwide countries, the gold price is dollar-denominated, therefore, the fluctuations of dollar rate has a great impact on gold price.

Generally, dollar falls, gold rises and the dollar rises but gold falls. In Pakistan case is different, dollar exchange parity and gold prices go in the same direction. The Pakistani rupee has declined by almost 40 percent over the last 10 years and this gives gold an extra lustre as an investment: gold prices are denominated in dollars, making it a good security in Pakistan. As rupee depreciates, people start converting their assets to dollar and gold.

Predicting currency movements is perhaps one of the hardest exercises in economics as it has many variables affecting the market movement. The destabilizing effect of the current financial crisis is putting pressure on the policy makers to form stable and consistent policies and bring the country out of current situation. Hence, Pakistan needs to adopt policies to maintain a stable exchange rate; to lessen the exchange rate risk, increase its international confidence and safeguard its foreign currency and gold reserves.

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