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The currency finally changed its direction yesterday – at least for a day. SBP did not just need to intervene in the market but also had to give a verbal warning signal on TV. The strong worded posturing by the central helped arrest the one-way movement of the Pak Rupee, that was blamed on speculators. But underlying fundamentals cannot be changed by mere statements. More is warranted to curb demand in days of rising commodity prices.

The market-based exchange rate is relatively a new phenomenon, and markets get jittery when the Pak Rupee starts sliding. Some say that gradual but one-way movement is a killer, as it adds to the uncertainty. But when that drip-by-drip movement is in the other direction, it pumps blood in the market. SBP’s stated policy is to curb volatility and not direction, thus the market must learn to not move too much in any single direction that leads to jitters once it changes gears later. For this to work. market needs to unlearn the past practices of sharp movements in the aftermath of full-blown crisis.

The other element is analysts, anchors, and commentors need to understand that both fundamentals and sentiments move the exchange rate – just like in the case of stock prices. If the market is moving too much, market participants must be made answerable for its direction, not the central bank. Asking SBP about market-based exchange rate movement is an oxymoron. The mindset must change.

Nonetheless, SBP’s stated policy is to intervene only to address disorderly movements that cause extreme volatility. But at times, small interventions may not be enough to change sentiments. And to do more, SBP Deputy Governor came on a TV show and gave straight macho style warning four times in sixteen minutes. Speculators were taken head-on, as a day earlier, finance minister in a press conference had asked SBP to intervene to nip speculation in the bud.

This appears to be working. Market participants are of the view that this may ease the market for the next week or two at most. Thereafter, fundamentals shall drive the sentiments. SBP cannot come on TV and warn speculators every time. More is warranted, but what?.

Some commentators are of the view that SBP should intervene as reserves are at all-time high. Others believe that SBP has injected dollars in the past and should do so again. But the exchange-rate is now market based, and the currency must move in either direction. If SBP is expected to intervene, why should that intervention only be one-way?

Now lets attempt to answer why SBP is not intervening. One news report has hinted that SBP injected $1.2 billion in the last few months to stabilize currency. One must wonder what would have been the extent of depreciation had SBP not intervened? And the other question who would have supplied dollars had the SBP not intervened? How much reserves do banks have to finance current account deficit? The financing ought to largely come from SBP. The efforts should be on controlling current account deficit to manageable levels.

Some say that current account slippage is not due to overheating, rather, it is due to rising commodity prices. But what other way to control import other than curbing demand at high level of prices. The first line of defense is currency and it is depreciating. But too much depreciation has its adverse consequences. A balanced approach is warranted.

The second tool SBP has is interest rates. SBP should signal to increase rates and alter the forward guidance to give some comfort to the exchange market players. However, with one-third of money supply in hard cash, and too low consumer finance, interest rates would have limited efficacy.

The missing link is the fiscal side. Finance minister cannot expect SBP to keep burning reserves to support Pak Rupee while letting the current account slip. A coordinated effort by finance ministry and SBP needs to be in place to curb demand. Last year, monetary policy was expansionary while fiscal was contractionary. Now both are expansionary. That cannot work.

Islamabad needs to take actions. One is to increase the petrol price in line with international prices. Recent increase is welcomed; but more is warranted. Islamabad should increase gas prices in line with rising LNG prices to curb gas circular debt and demand. PSDP allocation speed needs to be arrested as 44% of budget allocation in first quarter is too much.

Islamabad cannot divorce itself from the reality and should not narrowly focus on growth in FBR and GDP. The aim should be to have sustained growth. For that to happen in days of rising commodity prices the policy should be to go easy on the growth paddle. And in turn policy direction in Islamabad should be to go along with SBP’s action on monetary policy to determine PKR/USD direction.


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