Don’t Fall in Love with Parity: Understanding Exchange Rate Depreciation (Commentary)

The Pakistani rupee has depreciated, against the US dollar, around 10 percent, since May 2021 (see Figure 1). This is a natural response of the exchange rate parity to swelling trade deficit, mounting inflation, and negative real interest rates. Considering the macroeconomic fundamentals of the Pakistani economy, it is expected that the rupee will remain under pressure and will continue on the fall. This situation raises several questions. What should be the response of the State Bank of Pakistan (SBP)? Should SBP intervene in the forex market or not save the parity? If yes, then how much? If not, then why? What should be the course of action of the government and the SBP in the long run?

This policy viewpoint will answer these questions and provide straightforward guidelines for the SBP and the government.