KARACHI, Dec 7: The merger of inter-bank and kerb markets has been made a part of structural changes required in the Poverty Reduction and Growth Facility (PRGF) from the IMF, according to the first quarterly report of the State Bank for the year 2000-2001 released here on Friday.

The current uncertainty and low premium in the kerb market, says the State Bank report, “provides the ideal time to merge the two exchange markets”.

The SBP officials say that the pressure on the kerb market may be gauged by the fact that on several occasions, the kerb rate for cash transaction even dipped below the inter-bank rate. In overall terms, the rupee/dollar parity in the kerb market has appreciated by 8.8 per cent during July-October.

And the suspicion that the Hundi system is a possible conduit for cash flows to terrorist organizations, led to nervousness in the kerb market, that is dependent on the Hundi network.

Besides, the UAE central bank’s decision to enforce proper documentation of outgoing transfers of more than $500 had dampened money changer activities in Dubai which has served as a Hub for Hundi system.

The SBP report, however, acknowledges that there are still concerns about the sustainability of these developments. It is difficult to gauge whether the episode is the result of a temporary change in the market sentiments or a permanent shift in the kerb market structure.

It is, however, clear that the US government and its allies are firm about curbing flows to terrorist organizations. Any country that does not put in place necessary restrictions could face financial isolation. This means that the Hundi system would continue to be monitored closely which will keep in play the forces that have allowed the rupee to appreciate.

The SBP quarterly report singles out the collapse of the kerb market premium as “the most noteworthy event” on the exchange rate front after the US government began investigating possible cash flows to terrorist organization involved in September 11 attacks. “This resulted in a complete reversal of devaluation expectations,” the report adds.

Given the uncertainty that prevails in both the markets, the SBP officials say, “the kerb rate is once again setting the tempo of the inter-bank market”.

A variety of inter-related factors have contributed to the rupee’s strength in the kerb market that are providing some confidence to the policy-makers and the IMF to take steps to merge the foreign exchange markets. These include withdrawal of foreign exchange deposits after September 11, sale of dollars by relief agencies working in Afghanistan, the demand for Pakistani currency by Afghan refugees, decline in demand for hard currency due to fall in smuggling particularly through Afghanistan.

In the inter-bank market, the stability of the rupee is explained by the SBP report by the following factors: a) Drop in trade deficit in first quarter; b) Depreciation of rupee by 18.6 per cent during fiscal 2001 created expectations of a more stable exchange rate; and c) Pro-active management by the State Bank.

Indications are that the commercial banks may be allowed to set foreign exchange companies (FECs) and the money changers would be formalized into FECs. Commercial banks would be permitted to buy foreign exchange from FECs. All importers and exporters would be eligible to interact with the foreign exchange companies.

The target date for the merger of the foreign exchange markets would be indicated in the PRGF programme.