While the rupee depreciated by only 0.5 percent against US dollar, its depreciation against other currencies was far greater, said the State Bank State Bank Financial Markets Review issued on Wednesday. The rupee lost 0.5 percent against the greenback in 2004, 6.5 percent against euro, 10.1 percent versus yen, 9.4 percent to pound sterling, 0.5 percent to Chinese yuan, 1.7 percent against Indian rupee and 3.2 percent against Thai baht.
The rupee lost 1.8 percent against the US dollar in July-September 2004-05, 3.8 percent against euro, 0.5 percent against Japanese yen and losing against all other all currencies mentioned above.
The State Bank report says that the reason was that US dollar itself had weakened in the international market.
However, as the regional countries kept their currencies closely linked to US dollar, in net terms, the rupee was showing smaller deprecation against these regional currencies (such as Indian rupee, Chinese yuan), said the report.
The exchange rate in real terms depreciated during FY04 due to nominal depreciation of the rupee against US dollar. This was supported by weakening of US dollar in the international market against major currencies. However, the recent inflationary pressure has started to show up in real appreciation.
In fact, despite nominal effective exchange rate depreciation in Q4-FY04, rupee competitiveness eroded due to relatively high inflation rate in Pakistan, compared to trading partners. Thus, in real terms, the rupee rose by 0.4 percent in Q4-FY04 entirely due to 0.9 percent increase in relative prices compared to its trading partner.
After remaining relatively stable in Q4-FY03, interest rates came under renewed (downward) pressure in the first two months of FY04 amid a sharp rise in interbank liquidity. Not only were the targets in T-bill auction high and acceptances in the auctions well above targets, the SBP also mopped up much more liquidity through OMOs, compared to previous year. Nonetheless, the acceptance cut off fell in every successive auction during the period.
By August 2003, domestic interest rates dropped to record lows, wiping out the differential between benchmark rupee and US dollar interest rates. This raised pressure on the local currency as traders quickly switched to foreign currency (FE25) loans with rupee funding, effectively draining liquidity from both, the forex and the rupee interbank markets. This correction in interest rates was supported by SBP through (a) curtailing its forex purchases (to contain volatility in the exchange rate), and (b) an increase in the acceptance cut-off in the T-bill auctions.
While short-term interest rates in the secondary market also remained high in the same period, this probably owed also to: (a) a fall in interbank liquidity; (b) stable interest rate expectations for long term and (c) the expectations that SBP would be forced to reduce its NDA through open market operations to keep it below the target for the half year..
The policy statement envisages that the increase in money supply will be kept below the rise in nominal GDP during FY05. Accordingly, SBP raised the cut-offs of 6-month T-bill rates by 80 basis points and mopped up Rs 133.4 billion through OMOs during July-September 2004.
However, the impact of this tightening was not too evident in credit growth, which continues to accelerate.17 If this credit growth continues in Q2-FY05 and inflationary pressures do not ease, it may be desirable for the SBP to further tighten its monetary stance.
The central bank was concerned that some small banks were also holding a large amount of PIBs in their books, and a sharp reversal in interest rates could potentially erode the capital base of such banks. Further, as PIBs were primarily designed as non-bank borrowing instrument, large banks' holdings were against the objective of this paper.