In the week ending Nov 1, the SBP gross reserves increased by $443 million to reach $8.36 billion. The rumor mill linked it to the so-called deal with a convicted politician. Earlier this week Governor SBP dismissed the notion by saying that the money did not come from an individual.
Here, the attempt is to explain the mechanism of change in flows; and to narrate that any buildup of SBP reserves through buying in the local market is manifestation of improved situation in previous weeks/months, as the dealing is mostly in forward position, and it appears on balance sheet (gross reserves) when the forward position matures.
Thus, in simple words, any flows came in the SBP gross reserves in the last week of October are probably reflecting better supply in the interbank market in preceding weeks/months- in Sep and Oct, and not because of someone getting bail or something in November.
Under the IMF programme, there is a quantitative target of Net International Reserves (NIR) (read “The reserves building journey”). In order to improve NIR, SBP has to improve the forward swap position where SBP short position had substantially increased in the last two years or so due to falling supply of foreign currency in the market. Lately, the supply of foreign currency has improved in the interbank market, and SBP (Since Jul-19) is buying dollars in forward, and when the positon matures, it starts reflecting in the SBP gross reserves.
The SBP does not usually buy dollars in spot, and mostly deals in forward market, These are off balance sheet, and come on balance sheet once the position is squared after maturity. After the sharp currency and interest rates adjustment in Jul-19, the demand of foreign currency fell, the current account deficit reduced, and the foreign portfolio investment started pouring in. All these have resulted in excess supply of foreign currency in the interbank market, and commercial banks have become net sellers. Now had the SBP not intervened, the oversupply could have put the pressure on the price of dollar down, but the central bank rightly so pounced upon the opportunity to improve NIR.
Rest is nitty-gritties- the current account deficit has reduced, but it is still in red – so based on this, commercial banks should be net buyers. Encouragingly, the portfolio investment in T-Bills is increasing in interbank market that is offsetting the CAD needs – cumulative CAD in Jul-Oct stood at $1.5 billion and part of it is financed by Saudi oil facility in financial accounts, and a bit from other normal flows including FDI. A big unprecedented jump came in portfolio investment where $441 million came in during Jul-Oct. But adding all those, the supply could not be net positive of demand.
There is another element – the kerb market, where the buzz is that people are net sellers of foreign currency for a few months i.e. those who were hoarding are selling. That is the reason the gap between kerb and open market has reduced, and that excess supply has resulted in bringing the dollar value against PKR down from 164 to 155. People sell these to exchange companies which eventually are sold in the inter-bank market, and since the supply is higher than expected demand, banks are net sellers in forward market. Here, the SBP comes in play to buy in forward to reduce its forward book liabilities.
The other element of conversion is seen in FE25 accounts, which from its peak of $7.4 billion in Aug-19 is down to $7.2 billion as of Nov 1. The money taken out is either directly converted into the interbank market or the cash is converted through kerb market, and oversupply in kerb market eventually lands in interbank market, and the SBP is buying in forward.
The CAD reduction is expected to be higher in November, and the portfolio investment is growing by the day. Expect more SBP’s forward position to be squared and that to be reflected in SBP gross foreign reserves in coming weeks. Stop speculating and do not think of one deal or the other when you see more build up in reserves. The SBP should continue buying dollars as it’s a long journey, and the need to build reserves to be at a comfortable position runs in billions of dollars. Good luck.