Independent Indian: Work & Life of Professor Subroto Roy

Path of the Pakistan Rupee 1947-1993
Subroto Roy, 1993

Note: This was part of a 1993 study I did as a consultant at the IMF in Washington in a project on exchange-rates and exports of “South Asian” countries.  The IMF is not responsible for its content.

“The Pakistan rupee traded 1:1 with the Indian rupee at the time of Independence.  As noted, Pakistan chose not to devalue with sterling and the Indian rupee in 1949, which led to the end of the common market which existed with India.  Almost six years later, on July 31 1955,  Pakistan with IMF approval devalued to Rs.4.76 to the United States dollar, again establishing the same par-value as India.

Pakistan did not respond to the 1966 Indian devaluation although the Pakistan economy had suffered similar shocks, especially the 1965 war with India and natural disasters and civil conflict in East Pakistan.  On July 22 1970, a fluctuating tourist rate was introduced, effecting a partial devaluation.  Demonetization of bank-notes in June 1971 and the civil conflict leading up to the December 1971 Bangladesh war led to considerable capital flight via the well-developed parallel market where the Pakistan rupee reportedly touched Rs. 25 to the United States dollar.
Following the breakdown of the Bretton Woods mechanism as of August 1971, the official Pakistan rupee began to appreciate because of its peg to sterling.  In September, Pakistan like India changed its peg from sterling to the dollar, thereby depreciating with the dollar.  But Pakistan stayed at the same rate that had been established since 1955 of Rs.4.76 per United States dollar.  As with India, it is possible that in the period 1949-1979 long-term damage was done to Pakistan’s competitiveness relative to other developing countries by highly overvalued nominal exchange-rates associated with an inward-oriented trade regime.
In May 1972,  Pakistan implemented a major exchange reform, unifying existing multiple exchange-rates and declaring a new par value of Rs.10 to the United States dollar, which implied a 130 percent nominal devaluation and 62 percent real devaluation.  After a small appreciation in 1974, the rupee was maintained at Rs. 9.9 to the United States dollar for the next nine years.  However, the real exchange rate appreciated by an estimated 20 percent in the first half of the 1970s, and then depreciated by about 8 percent in the second half of the 1970s.  Domestic inflation relative to foreign inflation caused further loss of competitiveness as the real rate appreciated by nearly 10 percent in 1981-1982.  Although the authorities were aware of a loss of competitiveness, they were unwilling to devalue the nominal rate for almost a decade.

Faced with a severe balance of payments situation, Pakistan in January 1982 finally abandoned the fixed peg with the United States dollar and pegged to an undisclosed currency basket with the dollar retained as the intervention currency.  The rupee was depreciated by nearly 20 percent in 1982-1983 and a further 11 percent in 1983-84, with real exchange-rate depreciations of 11 percent and 4.6 percent respectively.  A substantial improvement was recorded in the current account especially on workers’ remittances (accounting for almost the same as the entire merchandise exports of Pakistan) which rose by 30 percent over the 1981-82 level.  The nominal depreciation slowed in 1984-85, with slight real rate appreciation.  This became reflected in the current account with workers’ remittances showing a remarkable elasticity and falling by almost $300 million.  In 1985-86, the nominal exchange-rate was allowed to depreciate at a more accelerated pace.

The influence on Pakistan’s exchange-rate policies of India may be separated into different factors.  Pakistan’s initial decision in 1949 not to follow the devaluation of sterling and the Indian rupee was seen by contemporary observers as a statement of national sovereignty by the new country.  However, the detrimental consequences of this led six years later to Pakistani devaluation to the same par-value as India at Rs.4.76 per United States dollar.  Pakistan did not respond to India’s 1966 devaluation to Rs.7.50 to the United States dollar, and the Pakistani devaluation of 1972 to Rs.10 to the United States dollar was a change of policy specifically in the new circumstances following the 1971 war with India over Bangladesh.   The 1972 devaluation was in all likelihood long overdue, since, as already noted, both Pakistan and India may have sustained long-term damage during the Bretton Woods period from overvalued nominal exchange-rates in face of numerous economic shocks, especially natural disasters and wars with one another.

In relation to their mutual hostilities, overvalued nominal exchange-rates in India and Pakistan have been of course conducive to each country’s defence sector imports, although at the cost of mutual loss of competitiveness for export and other hard-currency earning sectors of in the world economy.

Pakistan did not nominally depreciate any further in the 1970s despite real exchange-rate appreciation.  The delinking from the United States dollar and the start of active depreciation did not begin until January 1982.  Whether this was coincidence or a response to the fact that India actively began to depreciate at the end of 1981 is hard to tell.  In any case, the Pakistan rupee and Indian rupee both depreciated almost in tandem during most of the 1980s  The extent of similarity was tested when the Indian rupee moved in the range of -1 to 1 percent, 1-2 percent on either side, and more than 2 percent on either side.  The greater the change in the Indian rupee’s bilateral exchange-rate with respect to the United States dollar, the larger the extent of similarity in movement between the Pakistan rupee and the Indian rupee.  In the Indian case, the large likely influence of the United States dollar has been noted, with the Indian currency depreciating less fast when the dollar was appreciating with respect to other major currencies than when the dollar was depreciating with respect to other major currencies in the 1980s.  The Pakistan rupee seemed to be maintained in the 1980s at a significantly competitive rate with respect to the Indian rupee — e.g. at 1.32 per Indian in 1986, 1.34 in 1987, 1.30 in 1988, 1.27 in 1989 and 1.24 in 1990.   This indicates a distinct change from the 1949 situation when resisting devaluation was seen as a statement of national sovereignty.
The large Indian devaluations of 1991 left the Pakistan rupee at 1.06 per Indian, and in 1992 at 0.97.  The major changes which have taken place in the Indian exchange-rate regime in 1992 and 1993 have been followed closely by the Pakistan authorities and public.”