Dollar Doom Loop and Pakistan

The era of cheap money is over. The global financial crisis of 2008 led to an explosive growth in money supply with close-to-zero interest rates in US$ and other major currencies, triggering a demand for increasingly risky assets. Further increase in money supply post pandemic further flushed the world with excess liquidity, resulting in too much money chasing too few goods. When such a scenario materialises, that results in inflation, as prices of goods and services are bid up given excess availability of liquidity.

The monetary phenomenon driving demand pull inflation was further compounded by supply constraints during the last eighteen months. Initially due to disruptions in the supply chain due to the pandemic, and then due to the Russian invasion of Ukraine which sent shockwaves through the energy markets, eventually resulting in cost push inflation.

To rein in inflation, the US Federal Reserves has adopted a hawkish stance and has been increasing interest rates. As interest rates for US$ started increasing, there was an accelerated shift away from risky assets towards the US$, signifying a flight to quality. The US$ has appreciated by more than 15% against major currencies since the beginning of 2022. The US Federal Reserves continues to maintain a hawkish stance to bring inflation back within its target range.

As the US$ increased in value against all major developed and emerging currencies, US$ driven inflation fed into inflationary cycles across emerging markets, as they remain largely dependent on importing energy and food in key US$ terms, resulting in both energy and food inflation in local currencies. This triggered monetary tightening across all non-energy exporting markets, as economies scampered to avoid any major depreciation that could push them into an inflationary spiral.

Similarly, many emerging markets have issued US$ based sovereign debt.  As interest rates remained close-to-zero for more than a decade, many sovereigns were able to borrow at considerably low rates to fund consumption, and their trade deficits.  As the interest rates increase in US$ terms, and the value of US$ increases in local currency terms, there will be a double whammy effect. Sovereigns that would not be able to service higher interest expense, resulting in increasing deficits, and eventually spending cuts on social and welfare front, resulting in a high human cost. Sri Lanka, Zambia, and Ghana are some examples of sovereigns that are looking to restructure, or reprofile their sovereign debt. More countries may emerge as the cost of servicing the debt increases resulting in adverse developmental effects.

In view of a dollar doom loop rolling out globally, the most obscene policy a sovereign can adopt is trying to go against the flow and maintain an overvalued currency, particularly when it doesn’t have any foreign exchange reserves to maintain an overvalued currency.  Such a sovereign is Pakistan, which through political machinations is trying to maintain an overvalued currency despite suffering through a balance of payments crisis, as well as a natural disaster which has displaced more than 30 million people.

The sheer disregard to ensure sustainable economic growth, and to ensure ability to wade through a potential global recessions over the next few quarters is appalling. The short-term goal of maintaining an overvalued PKR would result in a heavy price that the country and its inhabitants would have to pay in the times to come. Restructuring of debt may provide some cushion, but if the opportunity is wasted by subsidising luxury consumption, and not for building back better following floods – the macroeconomic scenario would even be much worse.

The dollar doom loop is in motion.  We can either prepare for the same through policy measures that conserve foreign exchange reserves and bolster export proceeds through a competitive currency, or we can pretend that the world isn’t inching towards a recession, and that someone somewhere will bail us out.  We have had bailouts every few years now. The music has stopped. The punch bowl has been removed. Meanwhile, we continue to pretend that the party continues, much to our own detriment.

Ammar H. Khan
Ammar H. Khan
The writer is the chief risk officer for Karandaaz Pakistan, an organisation that seeks to promote financial inclusion in Pakistan. He has previously worked at several financial institutions in Pakistan, both in commercial banking and capital markets


  1. Exchange Overseas Pakistanis FX remittances to PKR on forced 25-50% lower rate at SBP, that amounts to $4 to 5b per year loss ($20b loss aggregate) to OPs to make available cheap & discounted dollar for importers & money launders. Robin hood technique? Govt makes its taxes revenue on imports turnover. Wao.
    This is how Mr Dar in previous PML-N government when maintained dollar “under control”.

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