KARACHI, Jan 8: Pakistan is likely to witness the launch of rupee derivatives in the money market and a further easing of trading barriers in the foreign exchange market in 2003 as part of the central bank’s policy to loosen its exchange rate mechanism.

The State Bank of Pakistan’s plans have been aided by a buildup in foreign exchange reserves to $9.5 billion, a tripling since 9/11, after Islamabad allied itself with the US in its war on terrorism, unlocking Western aid and attracting a flood of remittances from overseas.

The pile of reserves has also given the central bank room to ease its monetary policy and encourage banks to broaden the consumer lending market in which the use of derivatives to hedge long-term funding is widely used in other parts of Asia. “We would like to see derivatives and a new range of foreign exchange products in the market,” a senior banking official said. A senior banker at a European bank said the central bank is expected to focus first on creating rupee derivatives such as interest rate swaps and forward rate agreements, or FRAs. A legal framework for these instruments doesn’t yet exist, but a need for them is growing as Pakistan’s consumer and housing loan markets expand.

The country’s banks have turned to these markets to combat slower loan growth in other sectors and an absence of long-term industrial project financing. The next move by the central bank would likely be the launch of derivatives in the foreign exchange market, the banker said, such as rupee-dollar options. “Foreign exchange derivatives are still a bit far off at this stage, but in the first generation instruments we could see the launch of options,” he said.

The Pakistan Banks Association, a private body representing commercial banks, is expected to hold a seminar on derivatives in February to explain how these instruments would be introduced into the local market.

The central bank is also planning to beef up its reserve management skills and begin to dismantle existing barriers to rupee-dollar interbank trading. The State Bank will choose a consultant to advise it on where to place 10pc of the country’s reserves in the international market and how to look for pricing benchmarks. It is also preparing to set up an in-house reserve management department to handle the country’s expanding and increasingly unfettered foreign exchange market.

The local currency market has come a long way since 1998 when Pakistan imposed foreign exchange controls in response to international sanctions imposed after it conducted nuclear tests.

As these sanctions were lifted, Pakistan, under pressure from the International Monetary Fund, floated the rupee for current account transactions in 2000 and lifted restrictions that barred banks from taking foreign currency positions on the interbank market based on their balances held overseas.

This year the central bank is likely to go a step further, according to the banker at a European bank, easing restrictions on rupee-dollar trading by commercial banks that currently limit their net open positions to 10pc of their paid-up capital.

In the face of greater inflows of remittances and aid, the central bank has been buying dollars to prevent a rapid rise in the rupee — up almost 3pc against the dollar on the interbank market in 2002 — and thereby protect the competitiveness of the country’s exports. The senior banking official said these dollar purchases are expected to boost reserves even more, giving the central bank greater freedom of manoeuvre as it moves to free up the foreign exchange market.—Dow Jones Newswires