An eventful week as rupee makes significant gains

It was an eventful week ending on October 15, 2011, after previous week's 150 basis point discount rate cut. In the interbank market, the rupee gained over 1 percent against US $ to close at 86.55. Forward premiums jumped sharply as 6-month swap points traded at 380 paisa versus previous month's low of 260 paisa. Cut-off yield of 10-year Pakistan Investment Bond (PIB), most active trading government instrument, eased by 101 basis points to 12.2418 percent, and SBP rupee liquidity injection through its 7-day open money market (OMO) @ 11.66 percent surged to Rs 327 billion.
Pakistan's economy is severely bitten by low revenue earnings, high expenditure, high deficit, high inflation, and slow growth, caused by unfavourable overseas market condition and uneasy domestic market environment due to social unrest, energy shortage and natural disaster. Despite all economic ills, in remittances is Pakistan's only hope that is sure to rise above Rs 16 billion in the next three years, if the State Bank of Pakistan continues with its current strategy of stable rupee and maintained discount rate of around 10 percent. In real sense, remittances and exports are the backbone of this country's economy.
Recently, Pakistan suffered another setback as its trade gap of first quarter of FY12 widened to $5.114 billion due to rising oil prices in the international market and huge fall in remittances' inflow, which impacted the country's foreign exchange reserves as well, that fell by nearly $1.1 billion. I do not consider recent fall in remittances as alarming. Neither rupee touching new lows should be a worrisome factor. With forex reserves of $17.379 billion and manageable balance of payment, unless Pakistan's central bank decides to depreciate its currency, the rupee cannot weaken. While bank treasuries do not have the courage to take speculative/arbitrage rupee/dollar long- or short-trading position based on view or economic trend by utilising its net open position (NOP) to the maximum limit, and hence the rupee cannot become hostage to Pakistan's currency traders. In fact, banks' treasuries are given instruction by their management to square their books by the end of the day. Interestingly, on an average, our interbank forex market has never ever utilised 50 percent of their NOP limit, for trading purpose, fearing unfavourable move could cause loss to the bank. This is one major factor that causes volatility when there is $150-200 million oil/other payment and, if there is a follow-up payment in next few days, our forex market quickly gets nervous, resulting in mild volatility.
Unfortunately, instead of taking advantage of the pressure on the rupee by selling dollars, exporters turn into speculators. They hold their foreign exchange in the hope of big move, which, generally, fizzles out.
It is very strange that there is always a lot of hue and cry when the rupee comes under pressure at the time of big-ticket deals. For last couple of months there has been a lot of criticism from a section of the press, experts, analysts, economists and Tv anchors about the rupee's one-sided move, hitting new lows by losing 172 paisa, or 2 percent. Last week, it regained its lost strength to hit the highs of 86.43 per $ and the rupee closed at 86.60 per $. Did anyone notice that last week, on Monday, in a one single day, the dollar fell by over 2 percent against euro and lost 1.5 percent of value against other major currencies? Such 2 percent to 3 percent moves in a single day are very common in foreign exchange markets, which is often based on economic factor.
There are many factors responsible for the rupee's slide that caused uneasiness in the business circles. Markets strongly believe in discontinuation of IMF program that may add pressure on funding from donor agencies. While constant fall of rupee further scared overseas Pakistanis and the exporters, forcing them to hold funds in anticipation of sharp rupee's decline, the main causes of rupee's weakness were sudden release of lumpy oil payments at high price, shortfall in export collection and slowdown in remittances that had distorted SBP's payment plan. The pace of slowdown of inward remittances during last week before Eid holidays added further pressure on the rupee.
Furthermore, this time Eid holidays fell in the first week of September and in Middle East first 10 days of the month were relatively quiet. Similarly, in Pakistan banks had closed for 5 days. That slowed the remittances from USA and Europe. Therefore, my estimate is that overall decline in remittances could be of around $250-300 million. The move in the Kerb market was mainly driven by the demand coming from Hajj going pilgrims, which coincided with the pressure from the interbank market. The gap has narrowed down, which is again a point of stability.
However, since January 2011, minus China, Pakistan's rupee was one of the best performing currencis against dollar, and here is a comparison that how other currencies performed against $. Against $, Pak rupee lost 2 percent, Indian rupee lost 10 percent, BD taka lost 10 percent, Vietnam dong lost 6.5 percent, Malaysian ringgit lost 4 percent, and Taiwan $ lost 4 percent.
If we take volatility of major currencies in terms of percentage against US $ since January 2011, volatility in euro was 12 percent, Aussie dollar 12 percent, yen 11 percent, Canadian dollar 9 percent and pound 7 percent.
Therefore, I have every reason to believe that remittances' inflow would pick up in October and close above $1 billion mark. Pakistan has the potential to, and should, increase its share by attaining over forex inflow of over $12 billion by the end of FY 12, as global remittances are expected to rise to $440 billion by the end of calendar year 2011, out of which, flow to developing countries is expected to rise to $345 billion.
Due to falling oil prices in the international market, we are going to witness fall in the oil bill. That could improve the overall current account position, if not hit in some other area. Impact of oil bill normally takes 45 days. Hence, I have every reason to believe that in the next MPS, the SBP would specifically mention improvement in these areas.
However, I would partly hold the SBP responsible for the weak rupee for keeping forward swap premiums too low, for too long, which had discouraged our exporters to sell their forward dollars in the interbank market. Sis-month forward premium fell to 260 paisa and remained around and below 300 paisa for almost 4 months mean 5 to 6 percent loss for exporters, though SBP's perspective could be that it allowed low premium due to weak rupee. The positive sign that has emerged after 6 months swap premium, hitting Rs 380 paisa on Friday, is that despite cut in discount rate by 150 basis points, swap premium surged. That encouraged exporters to offload their foreign currency holdings in the interbank market. Six-month forward premium at 380 paisa means that exporters are once again enjoying market-based return, which is above 9 percent SBP's floor (corridor). Technically, based on interest rate differential, it is the SBP's responsibility to maintain swap premiums at the mid-point of corridor rate.
Meanwhile, slash in discount rate by 150 basis point is yet to provide any comfort to the market. Fall in remittances, exports and oil payments have added pressure on rupee liquidity. As we are approaching Eid ul Azha, it is expected that cash withdrawals for sacrificial of animal may exceed Rs 100 billion, which will further tighten the liquidity condition. SBP has already injected Rs 327 billion and this amount could surpass Rs 450 billion, which means currency in circulation could hit Rs 1.6 trillion. This outflow of money normally takes a minimum of 2 months to get bank into the banking system and, by that time, banks would be approaching December closing. So, it would not be wrong to say that the market is heading for an interesting closing year.
However, the market is quiet on Rs 400 billion energy sector inter-agency circular debt front. I think, the right strategy should be to wait for a couple more f PIB auctions, which would correct the market price in true sense. This I say because prior to 150 basis points discount rate cut, SBP through its OMO injections had provided the banks with liquidity of Rs 300 billion, which was invested by banks in government securities at the rate that was higher by 150 basis point. Hence, banks which jad obtained funds through OMO injections of Rs 300 billion are blessed with profit of Rs 4.5 billion (courtesy SBP) after the rate cut, as funds were already in the banks' possession. Now, if the banks are asked to return the funds these are available at a cheaper rate since discount rate has been slashed from 13.5 percent to 12 percent.
This week, T/Bills auction will take place for the first time after the rate cut and the auction target is Rs 250 billion, against maturity of Rs 235 billion. On Friday, the SBP injected Rs 327 billion through its open market operations (OMO) to meet the liquidity shortage and to make T/Bills auction successful. The biggest challenge faced by SBP is cut-off yield, as banks have and DFI's have been constantly bidding at a cheaper rate through OMOs, and investing those funds in T/bills at higher yields. Banks are enjoying this arbitrage offer due to SBP's desperation to sell T/bills, which is due to erroneous interest rate structure that needs to be corrected. I suggest that the central bank should either abolish corridor immediately, or align its floor (corridor) with the minimum savings rate. Abolishing of corridor would ultimately ease pressure of high yield demand by banks on government securities fearing risk of low return on overnight placement. If SBP can have 5 percent floor on PLS rates and allows 6 month forward premiums to fall to 260 paisa, then it is unfair to have 3 percent corridor rate gap. This imbalance needs to be corrected at the earliest.
FX & Gold Weekly OutLook, October 17-21
With uncertainty prevailing all over the globe, foreign exchange market lacks direction as there is significant downside risk to global economy, which is yet not addressed. Despite so many pending issues, euro regained strength on belief that the ECB would soon announce restructuring debt plan and banks' capitalisation. Although this issue is supposed to linger on for another 20-25 days, reports emerging from G-20 meeting suggest that it had told euro zone to fix debt crisis in the next 8 days. This would be interesting to watch. There are talks circulating in the market that the size of bailout amount could be up to euro 2 trillion. This could also mean that the ECB would go for quantitative easing, which is unlikely to support euro. The current bounce-back is also based on optimism that EU leaders' meeting will come up with a positive note and some sort of bold action will be taken. If EU announces corrective measures and announces imposing economic reforms then euro can make some more gains. However, any disappointment could have adverse impact on the currencies' sharp gain.
GOLD - $1681.15 Gold: could make some more gains on G-20 and EU optimism and Indian buying due to Hindu festival pf Diwali. Banking reforms means quantitative easing, which would always help gold buying. But these are all talking unless implemented. A break of $1698 is required for more gains with next level to watch $1715 or $1740. However, strong support is at $1645 or $1620. Range for the week $1645-$1740
EURO - 1.3882. Expecting a volatile week ahead, with possibly euro to resume its last week's gain and could challenge 1.4025, only break would encourage for 1.4220. A dip below 1.3820 would see a test of 1.3680. Ranges for the week 1.3680 - 1.4250
CHF - 0.8917. Buying on dip remains my preferred strategy, as 0.8750 is the level to watch should hold for 0.9080 or 0.9280 or else. 0.8690. Range for the week 0.8690 - 0.9280.
GBP - 1.5819. Would wait to sell Pound around 1.5950, for a dip below 1.5720 that will open gates for 1.5620 Or else 1.6095. Range for the week 1.5620-1.6050.
YEN - 77.21. Range trading will continue with bias on the upside as $ is buying on dips remains a preferred strategy. Ranges for the week 76.40 - 79.30.