By Syed Fazl-e-Haider

KARACHI – Government efforts to curb black-market currency dealing in the US dollar may be backfiring. The difference between the unofficial and official exchange rates is widening on strengthening dollar demand after the Pakistan central bank recently made it mandatory for everyone to show their personal identification card for greenback deals.

The exchange rate for the rupee crossed the 87 mark against the US dollar in the open market this week, while being traded at 85 in the inter-bank market.

“For the first time in the past one-and-a-half years, the difference in the exchange rate of the open market and inter-bank market has reached two rupees,” the News reported, citing Malik Bostan, an exchange company owner. The spread has recently been hovering around 170-190 paisas, compared with its historical average band of 15 to 20 paisas.

People are reluctant to sell the US currency to exchangecompanies because they do not want to disclose their identity. That is helping to drive up its value compared with the rupee.

The weakening local currency – as recently as 2008 it was trading at little more than 61 to the dollar – is contributing to a contraction in economic activity while promoting smuggling, which is also strengthened by government increases in import levies aimed, in turn, at offsetting the decline in rupee value. Critics say dollar demand is also growing due to low vigilance by the government’s investigative agencies in curtailing the unofficial, or black-market, economy.

Money used for smuggling and other illegal businesses in the black economy by definition evades taxes and its increased use is evident from the yawning gap between the US dollar open market rate and the interbank rate, according to the Business Recorder.

Economists say the government has to find a way of channeling this undocumented money so that it can contribute to fiscal spending and private sector financing and so help to reduce Pakistan’s dependence on donors and to regain economic self-reliance.

The government is making efforts to spur official domestic savings, which have declined by 6.5 percentage points to 14.3% of gross domestic product (GDP) in the past six years. An increase in domestic savings would help the government plug its deficit and provide much-needed liquidity to the private sector.

The country’s central bank has kept interest rates high to attract savers’ money, keeping its key policy rate at 12.5% in its Monetary Policy Statement for February and March, also with a view to keeping inflation in check. The central bank last cut its discount rate in November, by 50 basis points.

The bank’s stance has heightened the concern of local industrialists and traders who contend that keeping the discount rate unchanged will further increase production costs and help to destroy industries already suffering from exorbitantly high business costs.

The high interest rate has not prevented the rupee, which lost 23% against the dollar in 2008, and declined 3.5% in the last six months of 2009, from continuing to depreciate against all major currencies on a day-to-day basis. The currency is also devaluing despite a central bank forecast that foreign exchange reserves will reach US$15 billion by the end of June. Higher foreign exchangereserves are usually a positive for the exchange rate.

A weakening rupee contributes to inflation at a time when soaring prices of essential commodities, including foodstuffs, are already making the lives of the poor and the lower middle-class difficult.

Exchange rate stability is also essential for growth in per capita income. On the basis of an exchange rate of 61.30 to the US dollar, per capita income increased to $1,085 in the fiscal year to June 2008 from $926. That was before the rupee plunged to 80 rupees in the following months amid a worsening current account deficit that led Islamabad to seek an emergency loan package from the International Monetary Fund in November 2008. The deficit, which crossed $15.6 billion that year, narrowed to $3.44 billion in 2009.

Some analysts believe the rupee will remain under pressure as the country’s external debt continues to pile up and foreign investors’ concerns increase due to Pakistan’s worsening security situation.

Nor has the rupee’s free fall helped to increase exports, which have been stagnant for the past two years. Industry in Pakistan is heavily dependent on imported raw materials and components. Any increase in the price of such inputs through devaluation tends to raise industrial costs and reduce capacity utilization.

“The costs of currency devaluation are many, particularly for a predominantly importing country like Pakistan,” The News reported Faisal Qamar, a chartered accountant, as saying. “Devaluing your own currency is a direct way of subsidizing another country’s consumption.”

The central bank forecasts that overall real GDP growth in the year to June 30 will rise to between 3% and 3.5%, from 2% in the previous fiscal year. With population growth at 1.9% per annum, the country’s real GDP growth of less than 2% indicated a negative growth in per capita income in the fiscal year 2008-09.

Syed Fazl-e-Haider (www.syedfazlehaider.com) is a development analyst in Pakistan. He is the author of many books, includingThe Economic Development of Balochistan (2004). He can be contacted at sfazlehaider05@yahoo.com