US dollar versus PKR

The State Bank of Pakistan (SBP) has held a couple of meetings with foreign currency dealers and members of the Foreign Exchange Association of Pakistan on the need to weaken the US dollar in the open market and stipulated that the difference in value between the inter-bank rate and the open market must not exceed one percent. In this context, it is relevant to note that while the inter-bank rate is regulated by the SBP, which unfortunately remains susceptible to instructions from the Ministry of Finance, yet the currency dealers operate in a deregulated market where the exchange rate is determined by demand for the greenback and its supply which, in turn, can be manipulated by the SBP through engaging in bulk sale or purchase of dollar from the open market. In all economies, including Pakistan's, the central bank has the required wherewithal to manipulate the rate of the domestic currency - a wherewithal that of course is limited by the amount of reserves it holds.
Pakistan reserves peaked in October 2016 at 18.9 billion dollars, a couple of days after the final tranche released by the International Monetary Fund (IMF) under the 6.64 billion dollar Extended Fund Facility; and thence reserves began a steady decline lending credence to the IMF Mission Leader Jeffery Franks' statement that our reserves were mostly debt enhancing. With the cessation of the Fund programme, other multilaterals' and bilaterals' budget support shrank as their comfort level with the government's adherence to the reform agenda declined without quarterly rigid Fund monitoring. This prompted the government to begin to procure loans from the foreign banking sector at very high rates with a very low amortization period. Post-IMF programme completion, the government has borrowed a whopping 4 billion dollars from external banks - a figure that is expected to rise further in months to come. If the rupee value is allowed to be set at its market value, considered to be overvalued from between 15 to 20 percent, then the burden of these commercial loans as well as repayment of past loans/interest due will simply overwhelm our scarce budgetary resources.
By 13th October 2017, the SBP held total reserves at 14 billion dollars. Total imports from July to September 2017 as posted on the SBP website are estimated at around 12.89 billion dollars (with September figures noted as provisional) or in other words, the reserves are barely sufficient to cover three months of imports - a yardstick used to ascertain the minimum reserves required. Thus any intervention by the SBP to shore up the value of the rupee is sustainable only in the very short-term.
Economic theory dictates that an overvalued rupee would have negative implications on exports, which are rendered more expensive than those on offer by competitors, while encouraging imports which are relatively cheaper. Pakistan's deteriorating current account deficit reflects the fact that the rupee value may be having an adverse impact on our balance of trade.
To further complicate the foreign currency rates in Pakistan, currency dealers have been known to make the rate more susceptible to uncertainty (political or economic) than is merited and have been urging the government to allow them to receive remittances (at present they are allowed to receive home remittances routed through two international companies) which would increase their earnings substantially as well as allow importers of specific items (gold, automobiles, and some other commodities) to use the open market to purchase dollars which, they point out, has compelled them to use the illegal hundi-hawala method.
The question is how much should the rupee value be allowed to fluctuate at the present moment in time? The SBP has decided to weaken the dollar instead of the rupee and Business Recorder supports this stance given that at present there is dollar hoarding given that the market reckons the rupee will depreciate. However, its impact on the trade account may not be favourable and the small gains made in the past two months with respect to raising exports and containing imports due to fiscal measures may be eroded. At the same time, the reserves held by the SBP will deplete further. However, if the difference between the inter-bank rate and the open market rate narrows to 1 percent then the perception of uncertainty in the market with respect to the rupee-dollar parity would end that in turn would stabilise the value of rupee. A very careful rupee-dollar adjustment by the SBP is therefore required that would allow it to eat its cake and have it too.