IT is generally observed that after every 5-6 months there is turbulence in the foreign exchange market on the pretext of a shortage of dollars, which increases the market demand for the greenback.

As a result, the rupee depreciates, often sharply, against the dollar.

This attracts criticism, particularly from importers, which moves the central bank to intervene in the market. Better sense prevails after sometime, which brings stability in the forex market. However, this lull is again broken after a short period in the same manner and sometimes with more severity.

Under a managed floating exchange rate, the State Bank of Pakistan has to take into account a host of factors like demand and supply for the dollar, competitiveness of our exports, rising imports and our huge foreign debt. It is generally believed that the rupee is over-valued. Sometimes, the IMF also endorses such a view.

Owing to the large gap between exports and imports, coupled with increasing foreign debt, the rupee cannot be left entirely at the mercy of market forces. The central bank has to keep a close watch on external and internal factors that can exert pressure on the rupee.

On the external front, the strengthening of dollar in the international market or the devaluation of the currency of any of our trading partners/competitors works as a destabilising factor for the rupee. The recent devaluation of the yuan has affected the currencies of all of China’s trading partners, including Pakistan.

The SBP relied on market forces and succeeded in bringing the price of the rupee against the dollar to a new height on the pretext of the external situation.

The daily turnover in the forex market is in the range of $4-6m in normal times and $6-8m in turbulent times. On certain occasions, the SBP remains unmoved, giving its silent approval for the new price set by the market. This seems true in the current case of the yuan because all our competitors have devalued their currencies.

Meanwhile, internal factors work in two ways. Firstly, there are too many players in the forex market. These include banks, foreign exchange companies, a large number of bank customers maintaining foreign currency accounts, exporters/importers and others who understand this business.

Secondly, there is too much openness in the foreign exchange regime which allows every resident Pakistani to open accounts in four currencies — the dollar, euro, British pound and the Japanese yen. Furthermore, a common citizen is eligible to convert his rupee cash balances into the dollar. Speculation and outflow of hard-earned foreign exchange is made possible owing to this openness.

Players in the forex market build an expectational cycle on the basis of some international happening. For example, the current devaluation of the yuan fostered a whispering in the market that the rupee will lose against the dollar. Under such a situation, exporters delay converting their dollar proceeds into rupees on the hopes of getting a better rate.

Meanwhile, importers hurry for opening letters of credit, worrying that the dollar will become costlier in the coming days. The normal sale of the dollar slows down and its demand goes up, thereby a creating shortage of the reserve currency in the market.

The outflow of dollars through foreign currency bank accounts is small because a number of disclosures and documentation is required. But foreign trips are wholesale outlets of outflow under which millions of rupees first get converted into dollars and are then smuggled abroad through airports and seaports.

While the SBP has put in place a good number of reporting requirements for forex companies, these are not enough to stop the outflow of foreign exchange through undocumented ways and means.

In April, the SBP allowed exchange companies to conduct branchless banking activities as agents of commercial, Islamic and microfinance banks. This decision is likely to add more complexity to the forex business.

Foreign exchange speculation is largely done by local players. The situation might become more vulnerable if foreign funds start playing in this market. This happened in Thailand and Malaysia during the East Asian banking crisis of 1997-98 in which foreign funds played havoc with these otherwise strong economies simply through exchange rate speculations.

And the openness of these economies — i.e. free inflow/outflow of foreign exchange — helped global speculators make the central banks of these countries helpless despite having foreign exchange reserves of billions of dollars.

The recent devaluation of the yuan indicates, among other things, China’s economic might in global economic affairs.

China wants inclusion of its currency in the IMF’s reserve currency basket. In view of the slowing down of its economy, another devaluation of the yuan cannot be ruled out entirely.

It is also being speculated that a great deal of economic turbulence is likely to originate from the currency war between leading economies. Under such volatile situations, it would be too difficult for the SBP to safeguard the rupee’s external value in view of our increasing trade relations with China.

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