One of the important functions of a central bank is the prudent management of foreign exchange reserves of the country. Since the authorised dealers, mainly the commercial banks, perform agency function on behalf of the central bank in this regard, they are advised from time to time about their limits and the manner in which the foreign exchange is to be dispensed and purchased from the market.
According to a press release issued by the State Bank on Monday, 26th March 2007, the foreign exchange exposure limits of banks were increased from 10 percent to 15 percent of their paid-up capital. The revised exposure limits would, however, be applicable from 2nd April, 2007.
It may be recalled that in 1999, the International Monetary Fund had recommended the fixation of the aggregate exposure limit at 20 percent of the paid-up capital, but the SBP had fixed it only at 10 percent, with a capping at one billion rupees for individual banks. The cap has also now been raised to Rs 1.5 billion. In the case of banks incorporated in Pakistan, the limit would cover all the branches, including overseas branches, if any. The assigned capital required to be maintained by the branches of foreign banks in Pakistan will be deemed paid-up capital for the purpose.
The current aggregate of Net Open Position (NOP) of the commercial banks is believed to be around $190 million. With the enhancement of exposure limits now announced by the State Bank, the aggregate NOPs are likely to increase to about $290 to $300 million. In other words, the latest circular of the SBP would result in the increase in the banking sector's existing foreign exchange dealing capacity by $100 million. Such a step, according to the State Bank, was necessary "to further enhance the capacity of Authorised Dealers in order to manage increased volume of FX Market and to match future demand in the wake of growth in trade volumes."
In our view, the argument of the SBP to enhance the foreign exchange exposure limits of the banks is quite valid. Since 1999, the volume of foreign trade of Pakistan has increased sharply and freezing of the limit at 10 percent was not in line with the changed realities and would have acted as a constraint on expansion of foreign trade in future. The enhanced limit would not only allow the banks to meet chunky payments themselves but would ultimately permit oil import payments to be met from their own forex inflows.
Presently, authorised dealers have to buy foreign exchange from the central bank every time the payments for oil imports have to be made and this is an abnormal practice. Further, the enhancement of the FX exposure limit is a step forward in the liberalisation of financial sector and reflects growing confidence of the State Bank in its ability to maintain the foreign exchange reserves of the country at a comfortable level.
Capping of the exposure limit at Rs 1.5 billion for individual banks is also, on balance, justified. Such a capping is essential to avoid the assumption of a dominant position by a single player in the forex market and encourage smaller banks to play a greater role in the promotion of foreign trade and gain more experience in the foreign exchange transactions of the country.
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