The cat is coming out of the bag. The currency fluctuated considerably in the intraday for the second time this fiscal year; and the difference this time around is that the movement was planned and acknowledged by the central bank. The SBP is in its press release implied that the institution is all for market driven exchange rate adjustment and will intervene to discourage speculation.
This is going to be a managed float, and a clear policy departure from the sticky exchange rate policy. There are many questions and options that come to mind. Does the SBP have a level in mind to achieve in next few days or weeks? Is the IMF pushing the government? Does the country seriously face a balance of payment crisis? And the list goes on.
In terms of policy options, there are two school of thoughts. One is that the currency should be allowed to depreciate in a go to whatever the rates SBP has in mind, and let it remain sticky from thereon. The other view is what the SBP is adopting i.e. to stop intervening in the market aggressively and let the currency move bit by bit.
Proponents of the former say that the exchange rate depreciation expectations are so entrenched to elude any benefit of having slow depreciation policy. What do entrenched expectations imply? How to assert that market is anticipating a steep depreciation? And how would a gradual downward movement not serve the purpose of balance of payment stabilization?
One way to look at market expectation is to see the trends in FE25 deposits. The residents’ foreign currency deposits have increased by almost a billion dollar in this calendar year so far to reach $7.3 billion, which implies that depositors are losing trust on rupee current valuation.
The financing by exporters is declining; the foreign currency deposits financing has declined by $500 million, since June. Also, anecdotal evidence suggests that people are increasing dollar accumulation in vaults as they fear foreign currency deposit freezing.
The sudden increase in net banking reserves indicates that people are expecting currency to fall and they have started converting into dollars. (Read “Falling currency deposits” published on 9th August 2017).
The confidence can further be eroded by seeing the recently released foreign currency liquidity position by the SBP. The short positions in forward and futures in foreign currencies, is at an alarming level of $5.8 billion; it was $3.1 billion in Oct16. That was a time when foreign exchange reserves started declining due to sudden and, since then, persistent increase in current account deficit.
This implies that the fall in reserves would have been higher by $2.7 billion, had the SBP not increased short term swaps to brighten the picture. This trend cannot sustain for long; and may further deteriorate confidence on currency.
Seeing these indicators, amid the timing of depreciation coinciding with the IMF team visit; the perception of a fall in currency value has heightened. And a few think that gradual depreciation may not help at all in restoring confidence. They are of view that a sudden depreciation should take place and SBP should then manage float.
BR Research has been advocating that a sharp and sudden depreciation can bring more harm than good. It can completely halt the growth momentum and would bring double digit inflation back.
Thus, it’s a recipe to move from high growth and low inflation era to low growth and high inflation era. It doesn’t take an economist to understand what is good for the economy.
The SBP is finally doing what it was supposed to do since 2014.
It seems that Dar’s exit has brought a sense of independence to the institution.
The SBP should stick to its words and should rely on battery of good economists and currency market experts. There should be no interference from the finance ministry or PM office or even from the IMF
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