Exchange Rate Misalignment in Pakistan and its General Equilibrium Distributional Implications

Transcription

1 PSSP Working Paper Exchange Rate Misalignment in Pakistan and its General Equilibrium Distributional Implications Dario Debowicz and Wajiha Saeed December, 2012

2 Motivation Exchange rate trends The nominal exchange rate was flat at Rs. 60 per US$ for several years ( ) Since 2008, the rupee has been depreciating nominally Exchange rate policy is focused on inflation control, and short-term stabilization goals But what are the long-term real-side implications of Pakistan s exchange rate policy?

3 Exchange Rate in Growth Literature An important determinant of growth Not just exchange rate regime and exchange rate stability The alignment of the exchange rate is important Overvaluation harms growth Associated with stop-go cycles, BOP crisis, rentseeking Furthermore, undervaluation is conducive to growth Rodrick (2008)

4 We ask Is the exchange rate at it s equilibrium level in Pakistan? The real exchange rate may be overvalued The IMF calls for greater flexibility in it s 2012 Article IV report What would be the real side implications of allowing the exchange rate to get to its equilibrium level? Particularly on the structure of the economy

5 Structure of the Study PART 1 Econometric methods used to assess the rupee s alignment PART 2 A Computable General Equilibrium (CGE) model is used to assess the impact of correcting the (eventual) misalignment

6 PART 1 Measuring Misalignment We take the Behavioural Equilibrium Exchange Rate or BEER approach i.e. the equilibrium rate is defined in the behavioral sense We estimate the equilibrium relation between the real exchange rate and economic fundamentals Deviation of actual exchange rate from estimated equilibrium one taken as misalignment

7 Econometric Methodology The BEER is derived using (Johansen s) cointegration technique Uses a Vector Autoregression (VAR) Cointegration yields the long run relation Ensure that results are not spurious

8 Economic Fundamentals Variable Real effective exchange rate Real interest rate difference (r r*) Debt to GDP ratio Relative terms of trade Net foreign assets to GDP ratio Balassa-Samuelson Effect Increase in variable expected to cause: Appreciation Depreciation Ambiguous Appreciation Appreciation

9 Data Trends (Sample: ) LREER DEFICIT RDIFF LTNT LTOT NFA

10 The long-run equilibrium relation or BEER lllll = rrrrr ddddddd llll llll nnn

11 Total Misalignment: Actual REER vs. Sustainable BEER REER BEER (HP Filter)

12 Total Misalignment: Actual REER vs. Sustainable BEER REER BEER (HP Filter)

13 30 Total Misalignment in % Actual vs. Sustainable BEER

14 Misalignment & Growth 6 4 Total Misalignment GDP Growth GDP per capita growth (annual %) Total Misalignment

15 PART 2 CGE Analysis We use a CGE model to study the impact of devaluation In CGE analysis, we model the structure and the circular flow of income in the economy Allows us to simulate shocks to the economy

16 2008 Pakistan SAM Sectors (22) Agriculture (7): Wheat, Rice-IRRI, Rice-basmati, Cotton, Sugarcane, Other field crops, Other agriculture Industry (12): Manufacturing, Other food, Wheat milling, Rice milling, Sugar milling, Cotton processing, Textiles, Chemicals, Fertilizer, Cement, Energy, Construction Services (3): Trade, Transport, Other services Factors (3) Labor, Capital and Land Households (7) Rural (5): Large/medium farm, Small farm, Tenants, Non-farm poor, Non-farm nonpoor Urban (2): Urban poor, Urban non-poor Other Institutional Accounts (4) Government, Rest of world, Saving-Investment, Change in stocks. The government includes separate taxes for import taxes, direct taxes and sales taxes.

17 Our Simulations Simulation 1: Real devaluation of 10%, based on total exchange rate behavioral misalignment for period Simulation 2: Real devaluation of 25%, based on total exchange rate behavioral misalignment for year 2010.

18 Expected Structural Implications: Exchange Rate Devaluation Exports gain competitiveness; imports become more expensive However, imported intermediate inputs also get more expensive Hence effective subsidy to sectors with high portion of imported intermediate inputs changes, increasing their costs What is the final impact on relative size of exporting sectors; and sector structure of the economy?

19 Closures/Assumptions The share of investment in domestic absorption is fixed, with endogenous propensities to save. The government has a target deficit, with endogenous income tax rates. The real exchange rate is exogenous (flexible foreign savings), and the numeraire is provided by the consumer price index (fixed CPI). Factor endowments are fixed with full employment for every factor.

20 Output Prices BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade Transport Other Services

21 Output Prices BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade Transport Other Services

22 Output Prices BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade Transport Other Services

23 Value Added (Billion PKR; % Change) BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture 1, Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade 1, Transport 1, Other Services 2, Total 9,

24 Value Added (Billion PKR; % Change) BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture 1, Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade 1, Transport 1, Other Services 2, Total 9,

25 Value Added (Billion PKR; % Change) BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture 1, Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade 1, Transport 1, Other Services 2, Total 9,

26 Value Added (Billion PKR; % Change) BASE DEV10 DEV25 Wheat Rice Irri Rice Basmati Cotton Sugarcane Other field crops Other agriculture 1, Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Fertilizer Cement and Bricks Energy Construction Trade 1, Transport 1, Other Services 2, Total 9,

27 Exports (Billion PKR; % change) BASE DEV10 DEV25 Other Agriculture Other Manufacturing Other Food Wheat Milling Rice Milling Sugar Milling Cotton Processing Textiles Chemicals Transport Other Services

28 Imports (Billion PKR; % change) BASE DEV10 DEV25 Wheat Other field crops Other agriculture Other Manufacturing 1, Other Food Sugar Milling Cotton Processing Textiles Chemicals Trade Other Services

29 Real Wages BASE DEV10 DEV25 Labour Land Capital Index for labour and land in base; Assumed rental rate of capital in base; and % changes.

30 Annual Per Capita Income (000 PKR; % change) BASE DEV10 DEV25 Large & Medium Landlord Farmers Small Landlords & Tenant Farmers Waged Farmers Non-Farm Poor (Quintile 1 & 2) Non-Farm Non-Poor Urban Poor (Quintile 1 & 2) Urban Non-Poor Total

31 Conclusion Our findings indicate that Pakistan is presently going through a period of overvaluation This has potentially large implications for structure of the economy Overvaluation runs contrary to export promotion and economic growth goals Optimal exchange rate policy needs to consider these long-term real side implications in addition to short term stabilization and inflation control goals

32 End