Forward cover facility against imports

Central bank of the country appears to be in a confident mood. On Tuesday, the 22nd of March, 2011, the State Bank of Pakistan lifted its ban on forward cover for importers after a period of about three years, allowing them to book dollars for their future payments.
According to the circular issued in this respect, forward cover facility will be made available to importers against Letters of Credit (LCs) only and would not be provided for a period of less than one month. Rollover in those cases where import payment is not made in accordance with the schedule will be allowed subject to the condition that the rollover was not less than one month. Banks were also instructed to ensure that the facility was being availed for genuine import transactions only and importers do not hedge more than the underlying exposure.
Furthermore, if during SBP's inspection or at any point of time, it was found that the said facility was used for non-genuine transactions, action would be taken by SBP under Foreign Exchange Regulation Act (FERA), 1947 against the concerned bank and the importer. All cases where underlying LCs were cancelled will be submitted to SBP on maturity with full details, reasons and justifications, for further action by SBP as deemed appropriate in terms of regulations under the FERA, 1947.
The forward cover facility against imports is provided almost all over the world for hedging purposes ie to protect the importers from the losses arising from wide fluctuations in currency values. The cover, of course, is provided against the payment of an agreed fee, the amount of which depends on the degree of risk assumed by the insurers. The justification for the availability of the cover and its utilisation by the importer lies in the certainty and the confidence such a facility gives to the importer and other stakeholders like investors and other businessmen in planning their future activities through avoidance of the risk factor of excessive currency fluctuations. Unfortunately, the SBP had to suspend the forward booking of various currencies against all types of imports on July 8, 2008 due to a great deal of stress on the external sector and the risk of instability in the foreign exchange market of the country that could prompt speculative forces to get maximum benefit out of the situation.
In particular, it was feared that forward booking could be loaded with very high premiums. The situation seems to have completely changed since then. Driven primarily by a massive decline in trade and services deficit and high foreign inflows, current account deficit of the country has narrowed down by 97 percent to only $98 million during the first eight months of the current fiscal year as against $3.027 billion in the corresponding period of FY10 and foreign exchange reserves of Pakistan are now at a comfortable level of over $17 billion. As a result of this highly favourable trend, Moody's has maintained its credit rating B3 for Pakistan despite negative developments in most of the other areas. It is more than apparent, therefore, that the decision of lifting the ban on forward cover facility has been taken by the State Bank in the wake of improved balance of payments position of the country and the ensuing stability in the exchange rate of the rupee.
Although, there would now be somewhat higher demand for the greenback due to forward booking by the importers, yet the exchange rate of the rupee is not likely to depreciate significantly because demand emanating from this source is expected to be temporary and foreign sector of the country is projected to perform reasonably well in the remaining part of the year. Looking from all angles, the decision of the State Bank to restore forward cover facility appears to be based on sound assumptions and conceived on the right premise that it would help all the economic agents of the country including the entrepreneurs by facilitating importers and reducing unnecessary speculation in the foreign exchange market.