Recently, the central bank allowed importers to cover forward booking of imports after keeping a lid on it for almost three years. The forward cover for importers was suspended in July 2008, when foreign reserves had sharply fallen to 3 months of imports amid sharp correction in the value of the rupee.
Although, the allowance at that time was only against the opening of Letter-of-Credit (LCs) with no chance of speculative buying, virtually every importer was busy in buying dollars in advance against respective future payments.
The regulator had to do something to give a breather to the market. However, the move could not stop the rupee’s slide and the import cover was further reduced to its lowest level of 2 months by the time the IMF came to the rescue.
Now with positive external price shocks amid consistent growth in remittances through legal channels, the import cover has increased to 5.5 months -- giving the SBP the comfort level to allow importers to hedge against their future payments.
This facility for exporters to sell dollars in advance at the time of opening LCs remained functional even when the facility was suspended for importers. Lately, the exporters have been busy selling dollars in advance against their future export proceeds whereas importers have not shown much interest to cover forward booking since the re-opening of the facility.
The premium Pakistani banks charge on buying or selling foreign currency is primarily based on interest rate differential. But because Pak rupee is not a liquid international currency and is not considered fully convertible, demand-supply factors also come into play. In addition, there is a settlement risk. For instance interest rates in the US are at 1 percent while in Pakistan they are 13 percent, the cost importers have to pay on buying dollars in advance is little over 12 percent.
However, the market premium is reportedly around Rs2.25 and Rs4 per USD for three and six months respectively. This is slightly less than interest rates differential owing to higher supply of foreign currencies as growth in exports and remittances is outpacing imports.
The traders make their decision on their internal hedging polices and perceived exchange rate outlook. The exporters are busy in selling dollars in advance while importers are keeping on with the practice of payment-at-delivery. This depicts that the market perceives exchange rate to remain stable in coming few months.
That’s why exporters are comfortable in a contract today to sell dollar at a three-month forward price of Rs87.5/USD while spot price is Rs85.3/USD, as they expect rupee to not fall below 87.5 in three months time. On the other hand, importers are not keen to buy dollar in advance at Rs87.5/USD.
But, it is too early say on importers perception as they may take their sweet time to change the three years’ old practice of dealing in spot. Multinational importers, based on practices of their parent firms, will eventually start hedging imports payments despite the stable outlook on currency.
This means that the rupee can be expected to remain stable in the short to medium term as it has not taken any hit after resumption of forward import cover facility. But in the long run, interest rate differential which is based on inflation differential will determine the direction of the rupee.
The persistent high inflation in Pakistan versus low inflation in its developed trading partners will push the rupee to attain a higher level of higher equilibrium. The fact that the Real Effective Exchange Rate, computed by the SBP, has appreciated by 9 percent from Feb10—Jan11 augments the view that to restore the balance-of-payment equilibrium, a depreciation in Nominal Effective Exchange Rate will be on the cards.