Afghanistan’s central bank – Da Afghanistan Bank (DAB) – puts the onus of Afghani losing its strength on the ongoing political uncertainty. Historical exchange rate data show otherwise. The following graph illustrates that Afghani has lost its value against the United States Dollar (USD) by 41% since 2011, the downward trend started well before National Unity Government (NUG) and the emergence of current political standoff. Since the inauguration of NUG, Afghani has plummeted by 23%.

After eight years of stability, Afghani has persistently declined.

 

 

 

 

 

 

 

 

 

Social media response to recent falls in the value of Afghani was one of anger due to fears of spike in prices and decline in living standards in a country that imports almost everything. This means that Afghans will be paying more for imported goods, as reported by Pajhwok, including most staple food resulting in more pressure on family budgets.

Developing countries around the world has undertaken currency devaluation. Devaluation in Afghanistan is part of the larger trend that has been praised by International Monetary Fund (IMF). Pakistan, Egypt, Ethiopia are important examples where large currency devaluation were followed by painful increases in inflation. Despite high inflation, devaluation has resulted in higher economic growth for some countries. Afghanistan is in desperate need for such a result.

DAB has so far avoided criticism that they are deliberately allowing Afghani to lose its strength. However, the analysis above show that is not the case. DAB uses managed floating exchange rate policy in which it has partial control over setting the rate. Primary reason behind such denial is the possible implication that devaluation might have.  

Poor are affected the most by currency devaluation in terms what and how much they can buy with their income. Poor usually have little influence over their earnings and devaluation expose them to a dip in income. Less well-off part of the population also spend larger proportion of their income on buying necessities. When prices increase as result of devaluation, earning of the poor fall and their spending on necessary items increase.

People who are trying to accumulate their hard earned money in Afghan currency are another group that are hit hard by devaluation. The value of any saving decline in terms of purchasing power and ability to buy US dollar a shadow currency that Afghan rely on to avoid currency devaluation risk.

Businesses struggle to pass full increase in the prices of imported goods to consumers, especially if they want to keep their share of the market. That is business profit declines with possible implication for investment and hiring. Paul Krugman a noble wining American economist provided evidence that devaluation is contractionary at firm level.

A strong exchange rate can keep the prices of imported goods low resulting in increased imports and large trade deficit. Afghanistan has been running an outsized trade deficit for the last 17 years. One of the logics behind currency devaluation in Afghanistan is to increase our trade competitiveness and allow local industry to flourish.

Last year in April in a meeting with president Ghani, I asked him a question about the value of Afghan currency and its implication for trade competitiveness and development of Afghan industrial sector. His answer referred to many other impediments on trade competitiveness, while acknowledging that Afghani is overvalued compared to major trade partners. Economic theory and global practices has shown that exchange rate is one of the very important factors in managing trade flows in a country.

DAB policymakers committed a historical mistake in setting Afghani exchange rate extremely high in 2003, especially relative to USD and Pakistani rupee. Afghan markets were flooded with Chinese, Pakistani and Iranian goods as result. DAB at the time was more concerned about cementing confidence in the new currency then its impact on trade and industry development in Afghanistan. This effect was exacerbated by sharp declines in Pakistani rupee in the pursuit of increasing their export to Afghanistan and other countries.

Successful introduction of the new Afghan banknotes by Karzai administration with the support from international financial institutions was a remarkable achievements. Financial and Macroeconomic stability that followed restored confidence in the currency among Afghan people and businesses. Circulating new banknotes also successfully discontinued printing of Afghan currency by strong political groups and individuals who were accumulating wealth for themselves and their friends.

Afghans are still fresh with the memories of carrying heavy loads of money to buy daily needs such as grocery shopping. When currency depreciates by 41%, it kindles some anxieties among Afghan people that the currency could fall further. This makes it difficult for DAB to replace foreign currency circulation in certain parts of the country as the confidence in Afghani erodes.

While currency devaluation might be good for trade competitiveness and industry development, there are many other distortions in Afghan economy that will need addressing at the same time. DAB will need to carefully evaluate the risk of financial instability, effects on poor and loss of confidence in Afghani before further devaluation.

View expressed in this article are of the author’s own and do not necessarily reflect Pajhwok’s editorial policy.

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