Currency games!

The PKR/USD breached 158 level yesterday. Most treasuries were of the view that PKR/USD could cross 170, when it was north of 165. Forces of demand and supply are driving currency movements since July 2019. The currency has hovered in the band of 154-168 since then.

The sentiment is positive today and it can take rupee back to 150. Some say this should happen to bring the dollars from the lockers into the market. But this would put pressure on the current account. Exporters are already uneasy on the currency appreciation. If the PKR goes on appreciating, at some point they may lose orders. The SBP should look at the market holistically and intervene accordingly.

The objective of SBP should be to build reserves – and that would happen when the current account is in good shape, capital/financial inflows keep on coming, and exchange companies are the net seller. If the PKR appreciates too much, these three factors can shift poles. Rupee below 155 could not necessarily be beneficial.

The current account is in surplus in the last four of the five months. Till the time oil prices hover around $40-45/barrel and remittances remain at a run rate of $2.2-2.3 billion per month, the current account is in control. The economic activities are picking up and these grow faster with currency appreciation. If the currency appreciates too much, this can bounce back in the form of higher imports and lower exports.

The word on the street is that exporters are fully booked till June 2020. Many exporters are operating at full capacity and they are in the process of expansion. There are some advantages of currency appreciation for exporters, as they are importing cotton and other raw material at better prices, the expansion cost is going to be lower in PKR. But the core business margins are squeezing for some. The reason exports are at full potential or they are in expansion is that they don’t have any loss due to overvalued currency (as was the case in 2014-18).

In fact, the currency is now under-valued. And it should be kept undervalued for some time. It is the inertia of the past few years of overvaluation. The undervalued currency may help in building much needed reserves through achieving surpluses in current and capital/financial accounts. The cash holder of foreign currency in local markets may sell and that should help SBP in reducing its forward/swap liabilities.

One of the reasons, the exporters are in expansion phase and are getting big orders, is the undervalued currency. One of the reasons cash holders are net sellers (as per exchange companies’ representatives) for the past 16 months is undervalued currency as well.

The party should not be over. The reserves are built in the process; but are not enough. Prior to COVID, SBP reserves were at $12 billion and then the toll fell substantially and now it is back to similar levels. The comfortable level is nothing below $20 billion. There is some journey to cover for the SBP before they can sit and relax.

Many say that Pakistan should focus on services exports. Many say that foreign exchange regime should be fully flexible, on the premise that if the money flow is seamless, investment, services exports and goods exports will grow through promotion of goods and services abroad. By doing this, the incentive to keep flows outside through under and over invoicing would die. But for opening up of the regime, it would require a certain level of reserves, for making SBP to lose control as the depth would be enough to absorb any external crisis.

Thus, for moving towards fully flexible exchange rate and foreign exchange movement markets, reserves need to be built. For that, open market should keep on selling and interbank market should be in surplus. And too much appreciation can undo it.

The SBP’s stated policy is of adaptation of flexible exchange rate as a buffer against external shocks, with SBP intervention in the foreign exchange market limited to prevent disorderly market conditions and a possible exchange rate overshooting but not suppressing a trend. This would mean that the SBP may not intervene for the PKR to appreciate further. This means the PKR in the short term may go below 155.

It all depends on flows. The exchange companies are selling $10-12 million a day. This along with current account surplus is helping SBP to lower its forward/swap liabilities - down by $919 million in October and a similar run rate is continued in this month. Some say that $6-7 million foreign currency is being surrendered by cash holders every day.

According to money market people, this conversion can increase further. But for that, government has to give some cushion to informal foreign currency holders in the form of amnesty scheme or something. “They want to sell, but they don’t have an option”, added Malik Bostan, a key money market figure. Government should come up with a way to bring this money back into the system as this would help in gaining reserves.