IMF Conditions Keep Dollar Overvalued, Fueling Inflation in Pakistan
ISLAMABAD: A market-based exchange rate policy imposed by the International Monetary Fund (IMF) over the past two years has kept the US dollar significantly overvalued against the Pakistani rupee, according to a report by Tola Associates, a tax advisory firm. This overvaluation, estimated at 24% or Rs67 above its real value, has exacerbated inflation and increased interest payments.
In its Economy Alert note, the firm argued that, without the IMF’s condition, the rupee-dollar exchange rate would have averaged Rs211.5 by October’s end. Instead, the rupee’s value has weakened substantially, trading at around Rs278 per dollar in the fiscal year 2023-24.
Economic Consequences of Overvaluation
Tola Associates estimated the real average value of the rupee based on fiscal data from 2022-23, 2023-24, and the first four months of the current fiscal year. The firm highlighted that adjusting the exchange rate to this real value could have transformative economic benefits.
For instance, with the rupee trading at Rs211.5 per dollar, inflation for the July-October period, which averaged 8.7%, could have turned into a deflationary trend of 4.67%. Lower inflation would have allowed the government to cut interest rates to below 2%, saving approximately Rs6.4 trillion in debt repayments and creating fiscal space for development initiatives.
A mere 1% drop in interest rates could reduce domestic debt repayment by Rs475 billion in the current fiscal year, the firm estimated.
Government and Central Bank Perspectives
The State Bank of Pakistan, responsible for exchange rate management, insists that the current rupee-dollar parity aligns with market expectations. However, critics argue the central bank has maintained an artificially high exchange rate of Rs278 to a dollar, worsening inflation and increasing the debt burden.
Former finance minister and current Deputy Prime Minister Ishaq Dar claimed that the rupee’s value should not exceed Rs240 per dollar based on economic fundamentals. Dar, a long-time opponent of a flexible exchange rate, argued that such policies harm both the economy and the public.
According to Dar, the Real Effective Exchange Rate (REER)—which adjusts the rupee’s value for inflation relative to other currencies—suggested the rupee should trade between Rs235 and Rs240 per dollar in September.
The Role of the IMF
The IMF’s $7 billion loan program prioritizes exchange rate flexibility to absorb economic shocks and rebuild foreign reserves. This policy aims to stabilize monetary conditions and improve competitiveness.
However, critics argue that the IMF’s rigid conditions have led to negative consequences. Tola Associates pointed out that in September 2022, the rupee was trading at Rs238 per dollar under IMF conditions. However, when Ishaq Dar assumed office as finance minister, the dollar’s value dropped to Rs218 without any significant economic changes.
The central bank, meanwhile, has taken advantage of the undervalued rupee, purchasing over $6 billion from the open market in the last fiscal year. In July alone, it bought $722 million, primarily due to the artificially high exchange rate.
A Path Forward
Proponents of a stable currency argue for a shift in exchange rate policy. Tola Associates suggests that adopting the real average value of Rs211.5 per dollar could significantly reduce inflation, lower interest rates, and unlock fiscal resources for economic growth.
As the debate continues, the IMF’s market-based exchange rate policy remains a contentious issue, with critics emphasizing the need for a balanced approach that supports economic stability and public welfare.
