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Lockdown across many countries along with $2 trillion promised easing by US has put emerging market currencies under pressure. Currencies across the globe from Mexico (24%) to Thailand (5%) are down against USD in March. Pakistan currency was down by 3 percent till 23rd March.  In last three days, (24-26 March) the PKR slid by 4.7 percent to close at 166.1 yesterday.

Many say that its hot money outflows that has triggered the panic. The argument is slightly misplaced. Before 23rd March, outflow was already $1.5 billion (out of $2.9bn at the beginning start of month). That had triggered currency depreciation last week, but was controlled through SBP’s measured intervention. The outflow was higher in early days of fear and that had let the currency to fall. Thereafter, dip by dip is going out every day.

There is no reported sudden outflow this week. There was no bulk payment due yesterday. There has to be something more to the story. On 24th March, SBP reduced the interest rates by 150 bps in an emergency MPC meeting. This meeting coincided with PM’s fiscal package announcement. The currency depreciation of 4.4 percent in the last two days coincided with unexpected monetary easing. A wise man once said that there are no coincidences in life.

The story is that traders started taking loan from local banks in USD against FE25 deposits in this fiscal year. The confidence in domestic currency amid higher rates made foreign currency borrowing viable. One need to probe what boosted the confidence amongst traders (exporters and importers). For that hot money chronological story is self-explanatory.

When the interest rates peaked and foreign currency supply (through hot money, local conversion and loans from multilaterals) improved, the currency started appreciating and reached from its low of Rs164/USD (Jul19) to Rs155.7/USD in Nov 19. Lest we forget, till that time hot money inflow was mere $454 million. The real flows started coming in Nov-19 and by Feb-20 the amount peaked at $3.2 billion. SBP took the opportunity to build up its reserves and slash its off balance sheet liabilities.

Now when the hot money started evaporating in the aftermath of COVID-19 global panic, traders were a little agitated but panic button was not triggered. On 17th March, interest rates were cut by 75 bps. Business were disappointed as their major exposure is in PKR and in days of tight liquidity, higher rates could exacerbate cash flow situation. But there was no panic on foreign currency loan. There was no urgency for exporters to hold back dollars or importers to book rates quickly.

With interest rates down by 150 bps, the expectation of hot money outflow started picking up. Exporters that had a spread of 11 percent on borrowing against FE25 over PKR was reduced to 8 percent overnight. These two factors created an anticipation of currency depreciation and it happened right away. Remittances flows are already low due to lockdown in sender countries. Others may stop for a few days letting the currency to slip further.

A few are now joking to go long on dollar. That buzz was in the air prior to Jul-19.  Interest rates do effect investors psyche – be it domestic or foreign. During Jul-Nov 2019, currency appreciated due to domestic conversion. Foreign investors followed domestic footsteps. Now foreign investment is going out anyways and it is irrespective of carry trade spread. The domestic investor is more linked to domestic rates; and that has shown signs of conversion after the rate decline yesterday.

The important point is to not create panic. The message is to not go for dollar buying in days of humanitarian crisis. Times are not similar to last year. Interest rates have been reduced to provide relief to domestic businesses. Any rate depreciation could be detrimental for further easing.

Having said that, it’s not easy to buy dollars in open market now. And SBP may intervene to anchor expectations. The free fall in commodity prices is net beneficial for Pakistan’s external account. Hot money is already discounted in the equation and it may keep on evaporating. The quantum left is not big to create panic. Currency may show bumps every now and then; but its value may come back in the range of 160-165 soon.