Rupee depreciation: not so fishy

Depreciation of the local currency is making headlines once again just as it had provided fodder for media pundits back in September. But this time around, the movement of the rupee in the open market has largely mimicked its fall in the inter-bank market. While the gap between these two rates had widened from 20-30 paisas to more than 150 paisas in September; this time the divide has not been affected significantly. Pakistani rupee has looked weak since the start of this month, having slid by 1.6 percent as the countrys economic managers headed into talks with the IMF on Article IV review. But there are no signs that this weakness came about as a consequence of any recent prescription by the fund. The IMF generally asks the government or central bank to follow the movement in real effective exchange rate which is pretty much aligned now and for the medium term. Back in 2008 sharp rupee depreciation had occurred while negotiations with IMF were underway but at that time there was ample room of over 10 percent for adjustments in the nominal rate to align it with REER. So this movement in rupee is purely due to the interaction of demand and supply in the interbank market and the role of speculators operating in the open markets appears limited, at best. There is also, no abnormal movement in forward cover. In other words, importers are in no hurry to buy dollars and exporters are not craving an advance-selling spree. In a nutshell there are no signs of a bank run or a sharp southward movement in the currency market. Yet these sharp swings in the exchange rate warrant serious attention. Setting aside the argument that high volatility depicts a healthy market; the countrys balance of payments is vulnerable and the rapid depreciation of 15-20 percent in the Indian rupee witnessed in recent days highlights that the local currency could falter against the greenback. Since India is a competitor to Pakistan in export markets, any significant change in its currency has bearings on the Pakistani rupee. Add to this the fact that official estimates of financial accounts are quite rosy when compared to the projections of the IMF and independent economists, any unforeseen run down in reserves to the tune of $3.5-4.5 billion can have repercussions in the currency market. Conversely, if governments estimates hold true, SBP has enough in its arsenal to counter any wild gyrations in the exchange rate as effectively as it did back in September. Given Pakistans trade surplus of about half a billion dollars with Turkey; the much-touted currency swap with that country may actually mean fewer dollars coming in to the country. However, a similar arrangement with China appears a lot more promising given Pakistans hefty trade deficit with the Oriental giant. Sealing this deal can really hedge us against hefty outflows expected in the balance of payments. SBP has to be cognisant of the ground realities and should be cautious in its approach in todays monetary policy decision. We may be sitting comfortably for now, but an upsurge in inflation during coming months cannot be ruled out. Coupled with upcoming repayments to the IMF could put pressure on the REER as well as the nominal exchange rate.