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Where will the Pakistan rupee's slide stop?

Interventions into the market by State Bank of Pakistan (SBP), the central bank, though small and infrequent, have proved to be ineffective to stem the tide, so for.

SBP intervened in the market August 4 when the rupee sank and dollar rose to Rs59,30--59.40 in the inter bank market. It came on the back of heavy, and largely speculative, forward dollar buying by big business groups. SBP did not say what the volume of the intervention was, but market sources said, the central bank sold between $ 25 million in the market to stop the downslide. The dollar, after the SBP intervention and the warning, closed at Rs58.92, compared to the day's high of Rs59.30-59-40, and the previous day's rate of Rs58.79. The greenback closed August 5 at Rs58.86, moving at one point to Rs59.05. Pakistani currency has lost Rs0.74 Ð equivalent to 1.3 per cent - in 37 days starting July 1.

In the kerb, dollar that traded at 58.70/58.75 July 31, was down to Rs59.00/59.05 August 6.

The SBP's non-intervention policy that lasted until this week saw rupee sliding down rapidly. It appeared to be part of the SBP policy to let the rupee slide down to assist exporters stay competitive in the global market place, because their domestic cost of production is inching up, following a bit of tightening of the monetary policy. The tightening is leading to an across the board interest rate hike. The official export target for 2005 is $13.7 billion. SBP had unveiled this new Monetary Policy Statement (MSP) July 21. It is likely to stay in place at least till December 31. Already in a declining mode since March, 2004 because of the widening Balance of Trade (BoT) deficit, the rupee's further slide set in motion following the MSP announcement July 21. Fiscal 2004 had ended June 30 with a recent record high BoT deficit of $3.2 billion, mainly due to larger imports of machinery and industrial raw materials, as well as higher oil prices.

Added to this are other elements. These include the market speculation that rupee will slide down further in the near future, the ongoing flight of capital particularly to Dubai and the Gulf where new residential housing and commercial property is being offered to Pakistanis, and the speculation spearheaded by commercial banks regarding a greater fall in the rupee's value as a result of a $100 million foreign loan prepayment to a Japanese company by Karachi-based Pakistan Arab Oil Refinery Company (Parco). But the SPB got the prepayment by Parco postponed for three months to reduce the rush for dollars. The incident of the proposed Parco prepayment of just $100 million shows fragility of the rupee and the forex system on the one hand, and the degree of damage that speculators, forex exchange companies and banks, can do to the rupee-dollar parity. The intense speculation and the run on dollars, also brought out one of the rare warnings by SBP. Its Chief Spokesman Syed Wasimuddin said," SBP is vigilant and constantly monitoring the market. It will continue to manage the volatility in exchange rates and will not allow speculators to put undue pressure on the rupee." The statement was prompted by reports that big corporations, and industrial importers, including ten big textile tycoons, are making large speculative dollar buying in the forward market, against firm purchasing contracts, rather than the normal practice of doing it on the basis of Letters of Credit (LOCs). Such buying involves speculation because the veracity of "contracts" cannot be ascertained.

Officials told this correspondent, SBP also is considering steps, including legal measures, to ensure that the Gulf housing offerings do not encourage flight of capital from Pakistan.

SBP, this week, has been asking both foreign and domestic commercial Banks to slowdown dollar purchases for their customers, in order to take pressure off the market and restrain the greenback from rising. The Exchange and Debt Management Department (EDMD) of SBP, bankers said, asked them to unofficially cap the inter bank rate at Rs58.90. But, the banks did not seem to listen, as dollar continued to go up. SBP also offered to itself dollars to anyone at Rs58.90. SPB's Deputy Governor and head of treasury Zafar Shaikh said, " we are closely watching the exchange rates and will check speculative trading."

The fall of the rupee against the dollar has been rather significant, compared to its relative stability and, even appreciation, in fiscal 2003. The decline in the first two days of this week- August 2 and 3 -- alone was Rs 0.35 or 0.6 per cent when the greenback was traded at Rs58.90 on August 4.

SBP had stated in its Monetary Policy Statement for July-Dec., issued July 21, that it will monitor the interest-rate and exchange rate situation in the coming months. "The interest rates are projected to rise gradually in response to liquidity the liquidity constraints, rising interests rates in the international financial markets and inflationary expectations but their potential adverse impact on investment and growth will be minimised through better m monetary management and exchange rate management," it said. The rupee's travails started in early 2004,as dollar inflows slackened and demand for forex rose. The rupee-dollar parity began to indicate the impact of "a fast declining BoP surplus. The rupee depreciated marginally by 0.6 per cent in fiscal 2004, in contrast to a 3.9 per cent appreciation in 2003 and 6.8 per cent in 2002. The SBP intervened in the forex market starting March 2004 in order to ensure stability of the exchange rate and to stem the quick slide of the rupee against dollar. The central bank sold $461.8 million in the inter bank market during March-June, 2004. The gradual slide down of the rupee, however, improved the export competitiveness as the real effective exchange rate index showed a real depreciation 0f 2.8 per cent in 2004,compared to 1.6 per cent in 2003. A better competitiveness pushed exports to an all-time high of $12.1 billion. What is the outlook for the rupee-dollar parity? There is an outflow of liquidity from the banks on account of public purchase of shares of Pakistan Petroleum this week. The outflow on account of 205,750 small purchasers alone will, be Rs5.76 billion. "Soaring oil prices and attracting retail investors' liquidity through Initial Public Offerings by the government on account of sale of state enterprises may lead to a gradual devaluation of the rupee and increase interest rates," says a banker. The last few months saw a decline of $400 million in liquid forex reserves. The rupee has been under pressure in July as an estimated $2.0 billion were paid out on account of foreign currency debt servicing, loan pre-payments and trade and oil settlements. The interest rate scenario and importers' hedging led to a gradual increase in forward premiums, though they are still trading slightly below differential. One indicator of an improved popular sentiment for dollar holdings is the fact that foreign currency deposits in Pakistan are now up 16 per cent as investors are buying dollars to take advantage of the exchange and improved US interest rates. These deposits are known as FE-25, because they are regulated by Foreign Exchange Circular 25 of SBP.

I personally attach tonnes of weight to the weekend warning by soft-spoken, but candid and authoritative, SBP Governor Dr Ishrat Hussain on rupee-dollar parity. "Currency market players should not resort to dollarisation of the economy. Those who are involved in speculative business of dollars will be at a total loss in coming weeks. SBP has sold $700 million in the market. It indicates, we are active and know what are the needs of the market. Importers are unnecessarily rushing to banks to open letters of credit. We will protect Pakistani exporters, but they should be vigilant because in recent weeks, the Indian rupee has weakened against the US dollar. Exporters are competing against Indian exporters in the international markets. It is the duty of the central bank to provide a cushion to exporters so that they can maintain their edge in the international markets," he said.