Curbing Currency Volatility – Editorials

EDITORIAL: “The worst is behind us,” the chief economist of the State Bank of Pakistan (SBP) said in a recent podcast. He’s not wrong, so to speak. With the International Monetary Fund (IMF) program back on track, external financing needs for the year seem to have been secured. The sharp rise in the key rate has resulted in and would have the effect of dampening demand to reduce the pressure of imports on the current account.

However, on the exchange rate front, the SBP must be extra vigilant: it must try to stay ahead of the curve to curb volatility. That the short term cycle (weeks) of PKR/USD going from 210 to 230 and back is seriously hurting businesses is a fact. This is not the first seesaw since the exchange rate was eased (to be determined by market forces) in July 2019.

SBP has a stated policy of intervening where volatility needs to be contained without changing direction, which is now essentially market driven. The policy continues vigorously on the daily movement. However, volatility on a weekly or monthly basis often proves detrimental to businesses. As the exchange rate is flexible, speculators jump in; they make money fast due to currency volatility.

In the process, those not in the financial industry are generally worse off. Businesses dependent on imports for their raw materials calculate costs when making decisions at, say, PKR/USD of 180, and their realized cost could be around 230 (L maturity rate). /VS). This could make their decisions to import without any forward hedging unsustainable or bear the brunt of abrupt currency adjustments. Companies are rightly complaining that they are not in the forex business and should be somehow protected from the volatility of the PKR.

There should be appropriate hedging instruments that should be made available to SMEs (small and medium-sized enterprises) and commercial enterprises. Large companies attempt to hedge their exposure, but this luxury is not available to small companies. Banks have their own problems. They fear losses on days of high volatility because some used to run short positions and at the time they hedge the position, the movement of the exchange rate may result in losses for them. This is why they tend to charge a premium over the interbank rate while withdrawing the letters of credit in anticipation of hedging PKR’s movements at the time of clearing. Some banks expropriate and make speculative gains. This kind of practice has been seen in recent months. This must be taken into account.

There is also the growing difference between interbank rates and free market rates which makes buyers and sellers in the interbank market wary, and they make decisions to bring flows based on the gap. For example, when the PKR depreciated last month, the dollar in the open market was trading at a steep premium to the interbank market, and seeing this, exporters and other shippers waited for the interbank market to converge to market rates. free.

Conversely, when the direction reversed, the free market suddenly found itself at a steep discount to the interbank market, and this is one of the reasons for the surge of inflows in the interbank market. for a few days. There was enough USD liquidity within the exchange companies and the banks were reluctant to accept it. Their reluctance stemmed from fears that by the time cash moves through the accounts, the currency may have moved, which could lead to losses for the banks.

The exchange companies sat with higher banknotes and managed to convince the SBP to allow the export of US dollar notes. Exchange companies sent money abroad and were credited to NOSTRO accounts from which banks bought them on the interbank market. However, with higher USD exports, the free market ran out of currency and again the PKR started to depreciate faster in the free market. And this puts pressure on the interbank market.

There are also other reasons for the increased demand for foreign currency in the open market. The first is that the United Arab Emirates has made it mandatory for every traveler to carry 5,000 dirhams in cash to enter one of its emirates. This generated additional demand for the UAE currency. The other reason is that the Pakistani customs authorities have made it mandatory for travelers returning to Pakistan to declare currency holdings in cash. This caused people to bring less cash if not documented. This led to a decline in the supply of foreign currencies on the open market.

Today, the open market trades at a premium to the interbank. The gap narrowed after the approval of the 7th and 8th reviews by the IMF’s Board of Directors. But it is still above the historical normal range. SBP must strive to restore common sense and reduce volatility in the interbank market.

The central bank should also have a stated policy to curb volatility in the forex market – beyond day-to-day moves. He should be fully equipped to act and watch movements more vigilantly and should be ahead of the curve as he has more information than an average market player. And being back in the IMF program amid falling global commodity prices and full coverage of external financing needs, there is no reason to continue high exchange rate volatility.

Copyright Business Recorder, 2022

About Ruben V. Albin

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