Currency: Aftershocks to the system

The currency is slipping again. There is pressure on the currency for the last few working days in the open market rate and yesterday, the slippage was visible in the interbank market as well where the rate crossed the 290s mark for the first time, while the rate in the open market has crossed triple century.

One of the prime reasons for the slide in the interbank market is the condition of the IMF that the gap between open and interbank market cannot be higher than 1.25 percent (around Rs4 per USD at current levels) for five consecutive days. Thus, the interbank is catching up.

The question is, why is the currency not coming into control in the open market.“Dar is gone – now the currency is free to move”, candid reply of a currency dealer. The other factor is lack of free mobility of currency – there are limits on daily and yearly buying. There is significant tax on credit card transactions in foreign currency. These types of conditions are making people reluctant to sell when rates are better, as there are costs and frictions in terms of buying again.

Having said that, the general sentiments amongst the banking treasuries (who operate in the interbank markets) are that the payment pressure has increased significantly. The oil prices are moving up and there is an uptick of around $10 million or so on an average L/C of PSO. There is also a backlog of dividends payment, some agencies related and other payments, and that might put pressure on the currency.

Then there was some pressure on not opening lumpy L/Cs – one example is to allow the PSO to take loans on FE25 deposits for L/Cs payments, instead of paying through interbank purchase. Such practices were prevalent in the last few weeks when the finance ministry wanted to keep currency values in control. Now the control is perhaps unleashed and so is the currency movement.

Sentiments will also play a role. Upon a question that since the sentiment is better after the surprise IMF’s SBA and good news about Saudis and Chinese investment the currency should stabilize, the reply by a treasurer was that sentiments will only take you a certain distance; the rest is demand and supply.

Does this imply that there might be some more room in demand sterilization through hikes in interest rates?

Some banking treasurers are not keen on further monetary tightening, as they think that this might do more harm than the benefit of curbing the currency slide. Interestingly, one treasurer said that traders and manufacturers have started importing more than their current need, as they perhaps are expecting more depreciation. This means that the working capital cost is lower than keeping inventory. However, the same source was not in favor of interest rate increase either. Isn’t this intriguing?

Another source said that people are taking money out of the country and that is pushing pressure on the open market. They also said that sentiments have improved. But upon further probing, they informed that there was indeed a backlog of money that is to be taken out of the country- as people are selling real estate and taking the money outside Pakistan through formal and informal channels both. That implies that the sentiment improvement argument is absolutely hollow.

The bottom line is that the dollarization is not stopping even after narrowly avoiding a messy economic default. The onus fell on the economic management of the outgoing government where the Finance czar didn’t believe in the market economy and rather relied on controlling the markets. That was not a good idea, and its after-effects are in play now.