The dollar is losing its lustre as the rupee is gaining strength. Will Pakistan’s exchange rate remain stable?

The greenback is under pressure.The immediate cause is US interest rate that Federal Reserve Chairman Greenspan is not willing to raise unless he is sure that the US economy is on the road to sustained recovery. Fears are being expressed that the US may soon be in for another bout of recession.

On May 3, the dollar plummeted to six month low against Euro and a seven-week low against yen following the announcement that the US rate of unemployment has jumped to 6 per cent in April. Later, the greenback recovered some lost ground on news of productivity gains.

The longer term problem, impacting on the dollar value, is the weak fundamentals of the US economy, worsened by sharp slowdown in inflow of global capital that has, in the past, financed much of corporate investment as well as the US government spending.

Even, investors from the Middle East are reducing their stakes in dollars and are beginning to switch over to pound sterling and euro.

To quote BusinessWeek, “The US economic miracle is old news.The focus is now on capital flows. Dollar is losing its lustre.”

The rupee is stable around Rs60 to a US dollar as a result of the central bank’s sustained buying.Currency experts say that if the SBP were to withdraw its support from the greenback, the dollar will tumble to Rs.58-57.

The country’s reserves at $5.4 billion, that are likely to touch $6 billion by end June, are enough to prevent speculative attack on the rupee. The country’s current account surplus of over $2 billion in first three quarters add strength to the national currency.

In 1999, the central bank was empowered to buy foreign exchange from any source within or outside Pakistan. This mandate would be transferred to the commercial banks, as they would be authorized to purchase hard currency at negotiable rates from foreign exchange companies,(FECs) from August 1, 2002.

The State Bank is mopping up supplies in excess of demand from the inter-bank market and its purchases from kerb have dwindled and would be completely stopped from July 1.

SBP officials reckon that “ if most of the remittances are realized in the formal sector, the rupee would appreciate after the introduction of the FECs.”

A State Bank report says “launching of the FECs would also address concerns about the sustainability of the developments on the external sector...This will resolve the the most damaging structural problem Pakistan’s external sector has been facing since the last two decades.”

With remittances totalling $1.5 billion in nine months and expected to touch $2 billion this year, policy makers are getting convinced the inflows reflect a stable trend.

As the foreign exchange reserves continue to mount, market reports indicate that nearly half a dozen foreign commercial and investment banks are showing interest in generating business and are believed to be sounding the Central Bank on various proposals including management of soaring reserves.

Some thinking has also emerged in the State Bank that the surplus liquidity requires professional management for reserves. As the dollar rates are not competitive, the SBP, sooner or later, has to consider diversification of its holdings into various currencies. Presently, its portfolio is dominated by dollars. Outsourcing to investment banks, to manage reserves, could be one of the options.

However, the views on the issue are divided. Firstly, the performance of many global market players does not raise hope that the reserves can be managed efficiently by outsourcing. Their profits are down and their ethics are being increasingly being questioned.

In an editorial BusinessWeek says, “the public’s worst fears about the ethics of much of Corporate America are proving to be justified”.

It would be more appropriate for the State Bank to build a team of professionals who can be trusted to manage the forex reserves, currency experts say. As the relations with the west are subject to abrupt changes, whether it be 9\11 or nuclear blast, they say “outsourcing may be risky.”

While the US dollar is under pressure , the state of eurozone economies specially that of Germany, the largest and also the smaller ones, has not inspired much of confidence in the euro. Similar is the situation in respect of Japan and yen. Europeans, specially Germany, have to resolve their problems for the world to gain confidence in the euro, says a Pakistani currency expert.

But the slowdown of the American economy,its weak fundamentals,the volatility at the Wall Street aggravated by the worst scandals that has hit Corporate America and sharp drop in inflow of global capital, coupled with the demand of manufacturers and farmers for weaker dollar, indicates which way the wind is blowing.

Foreign corporations and institutional investors have been reducing their purchases of dollar.” The recent weakness of the dollar is a warning shot of what might be coming in the long term” says economist Jim O’Neill of Goldman Sach and Co.

Comparing the purchasing power of hard currencies, one estimate is that the US dollar is overvalued by over 30 per cent.

The fundamentals of the US economy are weak.US trade deficit soared to $31.5 billion in February, it’s highest in nearly a year. The budget surplus accumulated during the tenure of former president Clinton has been wiped out within a few months by the Bush administration to provide fiscal stimulus to a sagging economy and to repair the damages caused by 9\11. During 1996- 2001, the US household savings rate averaged 3.1 per cent, the lowest in the industrialized world.

A decade-long growth of the US economy is explained by massive inflow of global capital. Foreigners invested $355 billion in corporate bonds and equities in 2001 as compared to $276 billion a year earlier. They have funded everything from housing to corporate investment to government spending. In late 1990s, the US got a record inflow of direct foreign investment.

Now, that investment has come down to a trickle. Foreign corporations announced a mere $600 million in cash-financed deals in April , a sharp fall from $11.2 billion monthly average for past three years. And US economists describe it as a serious threat to the dollar.

The US data also reveals that foreigners bought $26.7 billion worth of stocks and equities in the first two months of this year against $100 billion during the corresponding period of last year. Over two-thirds of some 300 fund managers who responded to opinion poll by Merill Lynch in April said that stocks and bonds quoted at Wall Street were the most over-valued among the scrips quoted by world’s top five stock markets. Some economists predict that the United States “may compete for funds with emerging markets that offer faster growth but with more risk”. With US productivity up a huge 4.3 per cent over the past year, funds from overseas should not stop anytime soon, says Princeton University economist Alan S. Binder.