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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

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ASIF KHAN Sep 02, 2022 11:00am
A good editorial which is very easy to understand the complex nature of foreign exchange market. This is a good advice for the SBP to control the volatility on the market because it is very necessary for the economy.
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Riaz Khan Sep 02, 2022 06:53pm
Fully agree. We don't learn from history. In recent past Suger Mills Owners managed to export sugar, resulting in higher prices of the commodity in the local market. The consumers suffered. We can't see through a glass wall, leave aside the brick wall.
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samir sardana Sep 05, 2022 12:05am
IN A COUNTRY LIKE PAKISTAN ESPECIALLY IN TIMES OF STRESS LIKE COVID/UKRAINE/OIL AN GAS SPIKES - SHOULD BANKS CREATE OPEN POSITIONS ? "They fear the losses in days of high volatility, as some used to run short positions and by the time they cover the position" EVEN IN TIMES OF LOW VOLATILITY - HOW MUCH WILL THE BANK EARN,FROM THESE OPEN FX BOOKS ? IS IT WORTH IT ? BANKS CHARGE A PREMIUM OVER IBR AT THE TIME OF RETIREMENT ! Y ? I HOPE THE BANK DOES NOT BUY USD OPEN MARKET (THIS HAPPENS IN VIETNAM - IT IS A SCAM AS THE FX OPEN MARKET DELAERS KNOW THE DATES OF RETIREMENT,AND THEN,WHEN THE IMPORTER GOES TO BUY THE USD - DONG BLOWS UP ) BASICALLY- Y IS THERE A FX OPEN MARKET, IN PAKISTAN? AS SMALL EXIM CANNOT HEDGE ! THEY HAVE TO GO TO THE OPEN MARKET ! SBP HAS TO OFFER LOWER LOT SIZES, AND CHEAPER FX FORWARDS FOR SMALL EXIM TRADES EXPORT HEDGES ARE THE ISSUE ! AS THE EXPORTER,MAY DELAY REMITTANCE,AND THEN,THE FX FORWARDS HAVE TO BE ROLLED OVER,OR CANCELLED AND REBOOKED ! dindooohindoo
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samir sardana Sep 05, 2022 12:13am
FOR SOME IMPORTERS,1 simple solution is to provide incentives for financial consilidators.So the importer X, will pay a 10% advance to P -- a Pakistani company,which will open LC for supplier THAT 10% IS SECURITY,AND DEEMED LC MARGIN MONEY SINCE P is a financial consolidator,his turnover will be in millions of USD - so his bank charges, will be much lower,than if X,were to open THE LC X will also book the forwards,as the crystallisation date of payment,to the supplier is known ,and X now will have A DEFINITE PRICE - AND THERE IS NO NEED TO GO TO, THE OPEN MARKET FOR USD SINCE THERE IS A LC - ALL IMPORT DUTY WILL HAVE TO BE PAID (THERE IS NO WAY TO AVOID IT)
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samir sardana Sep 05, 2022 12:17am
FOR EXPORTER ON LC,THERE IS CRYSTALLISTION DATE SO THE DATE OF LC REMITTANCE WILL VARY BY A FEW DAYS FOR CLEAN CREDIT EXPORTS ON D/O BASIS AFTER 60/90 DAYS- THERE IS A PROBLEM SO SBP HAS TO DEVELOP AN FX OPTION PRODUCT,GIVING A RANGE OF PKR IN A BAND OF SAY 15 DAYS - SO THAT EXPORTERS CAN REALISE THEIR PLANNED OR BUDGETED PROFITS . AND IF THE MONEY STILL DOES NOT COME IN THAT RANGE OF DAYS - THEN THE FX OPTION,ROLL OVER CHARGES SHOULD BE MINIMISED
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samir sardana Sep 05, 2022 01:57am
IMPORTERS CAN ALSO HAVE A SIMPLE SCHEME.,WHEREIN,AS SOON AS THEY HAVE,THE BILL OF LADING SHIPPED ON BOARD - THEY GO TO THEIR AND DECLARE THE BLSOB THE BANK THEN,BASED ON TERMS ON PAYMENT, FIXES THE CRYSTALLISATION DATE,AND GIVES THE PAKISTANI IMPORTER,A FIXED PKR SO THE IMPORTER NEED NOT GO TO THE OPEN MARKET,AND CAN PLAN HIS BUSINESS THE BANKS AND SBP KNOW THEIR PRECISE DATE OF FX OUTFLOW,AND SO,CAN PLAN,AN OPEN HEDGE BOOK THE BANKS WILL SHARE THE DATA WITH CUSTOMS,AND SO FULL DUTY IS PAID SBP CAN USE THE OPEN MARKET FX,TO KILL THE IMPORT SMUGGLERS ,BY CREATING USD SHORTAGES AND CRASHING THE PKR,TO MAKE IMPORTS UNVIABLE - SO THAT DUTY PAID IMPORTERS, GET 1 MORE BENEFIT ! IF SBP WANTS, IT CAN CREATE SHORTAGE OR SURPLUS, IN THE CASH USD OPEN MARKET,TO MAKE LIFE MISERABLE,FOR THE PUNTERS! IF SBP WANTS TO !
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