One of the key issues facing the country is sliding of the rupee because of the widening current account deficit, falling foreign exchange reserves and unbridled speculation.

Speculation has been fuelled by relaxation of foreign exchange transactions rules. Until November 2001, banks were authorised to deal in foreign exchange and permitted to undertake purchase/sale of foreign currencies among themselves provided such purchases/sales were backed by the “permissible” transactions. This conditionality was withdrawn by the State Bank of Pakistan [SBP] vide F.E. circular No.20, November 21 2001.

In other words, speculative purchases/sales between authorised dealers were allowed. Like the oil price bubble in the crude oil market, one can deem that the current domestic exchange rate scenario is also the partial outcome of speculative activities by the big market players to mint money.

When the rupee is falling against foreign currencies, the authorised dealers stand to gain by building up foreign currency stocks as the SBP had abolished the limits given to the authorised dealers for maintaining foreign currency balances. In the past, the excess was required to be surrendered to SBP on day-to-day basis.

This condition was also abolished. Currently, the authorised dealers can maintain foreign currency balances(stock) without limit and the control is exercised by the SBP through the open position limits given to the dealers.

There was a proposal from some quarters that interest rates on foreign currency accounts should be enhanced to increase inflow of foreign currencies with a view to reducing pressure on rupee to arrest its fall. Until 1998, the amounts of foreign currency deposits were surrendered by the banks to SBP against payment of equivalent rupees and provision of forward cover by the SBP on payment of the prescribed fees.

The amounts of such deposits swelled to $11 billion which were mis- used for meeting balance of payments deficit. Therefore, withdrawals from such accounts in foreign currencies were disallowed in May,1998 [actually it was not freezing of accounts as the account-holders were free to withdraw money in equivalent rupees].This shook the confidence of the depositors and hence the scheme was revised and now the amounts of foreign currency deposits are not surrendered to the SBP.

The money is kept by the banks with them and is utilised for foreign currency lending or placement with their correspondents abroad; even though such holdings with the banks are “technically” taken into country’s foreign exchange reserves but the country cannot utilise these funds for meeting its day-to-day requirements. The enhancement in the interest rates on foreign currency deposits will in fact increase pressure on rupee as it would encourage more purchases of foreign currencies by the public from the open market. The resident Pakistanis make purchases of foreign currencies from open market for placing in the foreign currency accounts or keeping in their coffers while the foreign currency deposits mobilised from outside cannot be counted as “inflow” because such funds are parked by the banks outside the country. The proposal will merely increase pressure on rupee rather than reducing it.

To reduce pressure on the rupee, the SBP should:

* Monitor the daily open [exchange] position of the banks for the last quarter and if any bank has exceeded the prescribed limit, arrangements should be made to take back the monetary benefit derived by the concerned bank.

* Check the banks’ coffers to find out the foreign currency holdings. In case the volume of holdings suggest that any bank was indulged in speculative purchases it should be severely punished.

* Ban fresh deposits of foreign currency notes in the foreign currency accounts of the resident Pakistanis.

* Temporarily withdraw the authorisation given to exchange companies for making remittances in foreign exchange.

* No more foreign exchange be provided to exchange companies from country’s reserves as the money will find its way abroad by the unscrupulous elements for purposes other than those specifically or generally authorised by the SBP.

If these measures do not succeed, there will be no option but to revert to the fixed rate regime [the managed float system] as was in vogue from 1982 to 1998] which was administered by the SBP, as free fall of rupee will ruin the economy.

The writer is a retired Additional Director/Foreign Exchange ,SBP