Exchange Parity: ‘The Pugio’ – Zafar Masud on Pakistan Currency Management

There has been a considerable debate on currency management for a while. The pendulum of currency swung between defending currency to supposedly market based exchange rate in the recent times. The side-effects of both extremes are much clearer in hindsight and this may perhaps be a good time to look at their pros and cons objectively.

The best analogy for monetary tools, particularly exchange parity, to be used for correcting the external account imbalances is that of the pugio – a dragger of the sorts used by Roman soldiers as a sidearm. It seems likely that the pugio was intended as an “auxiliary weapon”, but it’s exact purpose to the soldier remain unknown. Whether it falls in the family of a sword or a dragger is yet to be concluded; it could be used either way depending upon the situation and it could, of course, back-fire, if
incorrectly drawn on.

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Publisher: The News International

Originally Published: November 2, 2020

This article was originally published in The News International on November 3, 2020. Read the full article on thenews.com.pk

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In conclusion, there shall not be any argument that the ideal situation is to have the market based exchange rate. The question is when and how? This write-up argues that it shall not be done in “isolation” – ie., the aggressive structural reforms has to be done in tandem with currency management which has to be done gradually with adequate intervals, if it has to be devalued at all, to avoid disruption in the market and ensuring that these measures are well absorbed by the market and keeping the prices/ inflation under control for general masses. The other argument here is perhaps that until the benefits of reforms are well embedded, it maybe a good idea to defend the currency as much a possible and this write-up argues that it’s surely worth while to defend the currency within reasonable limits. Devaluation in isolation, and independently, provides temporary stability only. The situation goes back to square-one in due course, if the necessary institutional initiatives are not done simultaneously, and the losses it causes in the market, in the meantime, becomes unrecoverable perhaps. Therefore, the focus shall be on reducing fiscal deficit caused by cash support to SOEs and subsidies to the inefficient sectors like power (leakages to be plugged) with better corporate governance and aggressive institutional reforms, rising over and above politics and political considerations. Rest of the aspects will fall in-place by default, including external account challenges to a very large extent, and then the monetary policy (both interest rates and currency management) will become more effective and useful.

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