Last week was a nightmare for global financial and commodity markets. Pakistan was no exception. Trading in stock market was halted thrice as volatility was high. With the emerging phenomenon of portfolio investment (hot money) in government debt market, the currency and bond markets in Pakistan are no longer insulated from global shocks.
The so-called hot money is also a regular feature in stock market, but the outflows in a short time are usually lower in terms of dollars, but the impact on index is high. Bond market movements have varying impact. The outflows are higher in terms of dollars, but their impact on yields is lower. Since the reserve base is thin, any sudden outflows can jolt the currency market.
SBP’s total reserves were $12.8 billion on 6th March. Market intelligence revealed that portfolio investment outflow was $800-850 million in the last week (9-13th March). Official numbers are showing lower quantum as rest will be settled this week. Total outflow in March alone is over $1 billion from $3.1 billion at the start of the month.
The outflow is around 2 percent of tradable government security market, thus there is no major dent in bond pricing. But in terms of SBP reserves, the amount is 8 percent and that has jolted the currency. On Monday, the outflow was $350-400 million, and the currency moved by 1.5 percent. The slide in the PKR against USD is at 3 percent for full week based on weighted average rates of 6th and 13th March.
The currency movement risk of portfolio investment has been highlighted by many pundits. It is a legitimate risk and currency market strength was tested last week. The good news is that for most of the week, SBP did not intervene and market buffers were enough to manage the sudden outflows. Currency movement is based on demand and supply and it depreciated due to abrupt demand.
SBP has been insisting for the last few months that there is enough cushion to manage outflows in hot money. SBP's announced policy is of a market-based exchange rate with intervention only to address disorderly market conditions. Last week was an extreme situation and SBP intervention was warranted to reduce volatility.
After the central bank intervention, currency in the second half on Friday moved back and is likely to open around PKR 157-157.5/USD today. It is hard to say how the currency market will move in days to come. It all depends on how global markets behave. If there is more blood on the streets, one can expect more outflows from portfolio investment in days to come. Currency could remain in pressure. SBP may intervene again.
The institution told BR Research that “SBP is monitoring the situation closely and remains ready to take any actions needed to address disorderly market conditions". The important point is that the current market volatility in Pakistan is driven externally and underlying fundamentals have not changed due to COVID-19.
This implies that when the dust settles on COVID-19 panic, the flows are likely to revert, even if the interest rates are cut. These funds see the real interest rates based on forward looking inflation. The inflows came in at real rate of 1-2 percent and these will stay till the real rates are in this vicinity. Now if the oil prices remain low while the global markets recover, Pakistan credit risk could improve given it is a net importer. This may result in higher flows coming in Pakistan as compared to earlier flows.