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Since July, the SBP reserves have increased by $1.8 billion while swap/forward liabilities are down by $1.95 billion. The commutative increase in Net International Reserves (NIR) is at $3.75 billion. That is a healthy sign. This indicates why the currency appreciated from its low of Rs164/USD to Rs155/USD. The interbank market is having excess foreign exchange liquidity and the currency may appreciate by another 2-3 percent in a few weeks’ time.

Some say that the SBP should buy excess liquidity to create reserves buffer and should not let the currency appreciate. Seeing the past four months’ data, the currency appreciation would have been higher if the central bank was not buying dollars from the interbank market. The process is likely to continue, but some liquidity will be deliberately left in the interbank market for banks to learn to deal independently.

Earlier (2016-18), the SBP used to supply the shortage of funds in the interbank market to keep currency intact. There is a consensus that it was a flawed approach. Similarly, sweeping all the amount from the market is also flawed thinking. For exchange rate to be market determined, market has to be developed. The banks have to work for parking excess liquidity and these learnings will be handy in days of shortage.

The mindset has to shift from fixation of currency parity. No defined level is necessary. It is a pricing measure and should move in both directions, based on fundamentals and demand supply dynamics.

The currency is appreciating because market thinks that early depreciation was a little too much.  Economic fundamentals have improved. The current account deficit is in control, and other foreign flows are pumping in. An important indicator is the forward market. The interest rate differential between Pakistan and trading partners to determine the forward spread – it is around 11 percent based on KBOR and LIBOR.

The forward cover is falling as exporters are trying to book orders in forward market. Earlier the exporters were delaying the proceeds. They have to bring it back in six months. The expectation was of currency depreciation and exporters were delaying. Now with currency appreciating, not only the backlog is falling, the orders are also sold in forward market. The influx is high.

Importers are trying to exhaust the credit limits to delay payments. That is increasing the flows too. Sooner or later, the cycle is to normalize and excess flows to diminish. The overall liquidity will be better, due to lower current account deficit. The portfolio investment is adding up to the interbank market liquidity. The amounts coming from ADB, IMF etc go directly to SBP and market liquidity is likely to remain unchanged.

The payment pressures starts building from 3rd or 4rth quarter of this fiscal. The SBP might not be providing excess liquidity in the market to support currency. At that time, PKR may depreciate. Banks need to create their own buffers to handle shortage.