All signs lead to currency appreciation

The currency is expectedly strengthening for the past three trading sessions. Market sources reveal that SBP marginally intervened on Friday with $20-25 million and there were debt portfolio inflows (hot money) of $200 million. But the market moved prior to that and the strengthening continued this week.

This has happened despite the fact SBP cut the policy rate by a surprise 200 bps on Thursday. The general expectation was of currency to depreciate on Friday. Anticipating that, SBP on Friday morning intervened with a meager $20-25 million. Since there was no payment pressure, the market reacted to that small amount to jump the currency up by 1.5-2 percent. This demonstrates that the general direction for the currency is to appreciate based on fundamentals.

The other surprising news was an inflow of $200 million on Friday that came at a time when the general foreign portfolio investor psyche is to exit emerging markets.  It is pertinent to note that this happened right after the surprise decline of interest rates by 200 bps to make the real interest rate at zero from 1-2 percent on forward looking inflation. This may help in breaking the myth that hot money was only coming due to high rates or rates were kept high to attract the portfolio debt investment.

The carry trade is still attractive. Pakistan rates are down by 425 bps, while the US rates are down by 2 percent. The carry trade spread is reduced by 225 bps to 9 percent and investors are still finding it attractive in such a dicey market. However, this does not mean that outflows will stop. Some investors may exit, others may enter. That is how markets behave.

That said, major outflow seems to have already taken place. The hot part of portfolio money is largely out and now the market is left with largely cool investors, who could probably wait for maturity and some may even roll over. And those who got out in panic have lost. The currency depreciation during those outflows has eaten major chunk of their return. Now the ones entering or sticking to fundamentals will make money as the currency is now appreciating again.

The overall external account liquidity has actually improved due to COVID. The current account is likely to be in surplus or marginally in deficit this quarter. This is better than earlier expectations. Oil prices are doing funny things and making records on lower side on daily basis. They may not come back to pre-COVID levels and that is good for Pakistan.

On REER, inflation is Pakistan is coming down faster than trading partners. The reason is simple, as Pakistan’s inflation was primarily based on food supply shock and that was reverting to normalcy and now COVID related demand shock and commodity prices suppression is making Pakistan’s relative inflation lower. This implies there is some room for appreciation on REER basis.

The real worry was capital and financial accounts. Almost $3.4 billion debt servicing was due this quarter. That problem is dealt with $1.4 billion inflow from IMF and around $600-700 million expected injection by WB and ADB each. This will cover $3 billion of expected $3.4 billion outflow. Now with talks on hold on repayment to G20 loans, and possible freeze on multilateral and commercial loans too, the outflow will squeeze substantially.

This is to bring liquidity in the currency market and seeing all the angles of valuation, there is no reason for currency to not get back between PKR/USD at 155-160.