EDITORIAL: ‘The worst is behind us’, stated the State Bank of Pakistan’s (SBP’s) Chief Economist in a recent podcast. He is not wrong, so to speak. With the International Monetary Fund (IMF) programme back on track, the external financing requirements for the year appear to have been secured. The sharp increase in the policy rate has resulted and would result in curbing demand to lower the pressure of imports on the current account.
However, on the exchange rate front, SBP needs to become more vigilant: it should try to stay ahead of the curve to curb volatility. That the short-term (weeks) cycle of PKR/USD moving from 210 to 230 and back is hurting businesses badly is a fact. This is not the first seesaw movement since the exchange rate was made flexible (to be determined by the market forces) in July 2019.
SBP has a stated policy to intervene wherever volatility needs to be curbed without changing the direction, which is now essentially market-determined. The policy is being pursued vigorously on the daily movement. However, the volatility on weekly or monthly basis often turns out to be detrimental for businesses. Since the exchange rate is flexible, speculators jump in; they make quick bucks due to currency volatility.
In the process, those not in the financial business, are usually worse off. Businesses dependent on import for their raw materials do the cost calculation at the time of making decisions at, for example, PKR/USD of 180, and their realised cost could be around 230 (L/Cs’ maturing rate). That could make their decisions to import without any forward cover unviable or bear the brunt of sharp currency adjustments. The businesses rightly so complain that they are not in the business of currency, and they should be somehow hedged against PKR volatility.
There should be proper hedging instruments that need to be made available for SMEs (small and medium enterprises) and commercial businesses. Big corporates attempt to hedge their exposure, but that luxury is not available to smaller businesses. Banks have their own issues. They fear the losses in days of high volatility, as some used to run short positions and by the time they cover the position, the exchange rate movement can result in losses for them. That is why they tend to charge a premium on the interbank rate while retiring letters of credit in anticipation of covering the movement of PKR at the time of clearing. Some banks expropriate and make speculative gains. This kind of practice was seen in the recent few months. This needs to be addressed.
There is also the growing difference between the interbank and open market rates that is making buyers and sellers in the inter-bank market wary, and they make the decisions of bringing flows based on the gap. For example, when the PKR was depreciating last month, the dollar in open market was trading at a steep premium to the interbank market, and seeing that, exporters and other senders were waiting for the interbank market to converge to the open market rates.
Conversely, when the direction flipped, the open market was suddenly at a steep discount to the interbank-market, and that was one reason for flurry of inflows in the interbank market for a few days. There were enough cash holdings of USD within the exchange companies and banks were reluctant to accept that. Their reluctance stemmed from fears that by the time cash moves in accounts, the currency could have moved and that could result in losses for banks.
Exchange companies were sitting with higher currency notes, and they managed to prevail upon the SBP to allow the export of USD currency notes. Exchange companies sent money abroad and got credited in NOSTRO accounts from where banks bought them in the interbank market. However, with higher exports of USD, the open market ran short of currency, and again PKR started depreciating faster in the open market. And that is putting the pressure on the interbank market.
There are some other reasons for higher demand of foreign currency in the open market as well. One is that the UAE has made it mandatory for every traveller to carry 5,000 Dirhams in cash to enter any of its emirate. That has generated additional demand for the UAE currency. The other reason is that customs authorities in Pakistan have made it mandatory for the travellers coming back to Pakistan to declare the cash foreign currency holdings. That has made the people to bring less cash currency if it is not documented. That has resulted in lower supply of foreign currency in the open market.
Today, the open market is trading at a premium to interbank. The gap has narrowed after the approval of 7th and 8th reviews by the IMF board. But still it is higher than the historic normal range. SBP must work towards bringing sanity and lowering the volatility in the interbank market.
The central bank should also have a stated policy to curb the volatility in exchange market — beyond daily movements. It should be fully geared to act and monitor the movements more vigilantly and should be ahead of the curve as they have more information than an average market player. And being back in the IMF programme amid the falling global commodity prices and full coverage of external financing needs, there is no basis for continuation of the high volatility in exchange rate.
Copyright Business Recorder, 2022