Stored old dollar bills worth $500m surfaced in the first two months of 2017 as panic stricken savers and hoarders rushed to exchange them at any price. Market sources confirmed a sizeable amount was traded at sub-market rates.

The ‘fright syndrome’ contributed to the sudden surge in dollar flow which eased pressure on greenback supply in the open market, observed market watchers.

The shrinking of the demand-supply gap helped bring relative stability in the value of a slipping rupee. The rupee recovered to 107 after crossing 109 to a dollar some time back.

The warning by the regulator on Feb 20 halted the trading of old dollar bills at sub market rates and further stabilised the situation. The State Bank of Pakistan directed commercial banks and money changers to accept old dollar bills of all designs and denominations at the market rate. It warned that those found flouting the said order would be penalised.

The duality of the exchange rate for old and new dollar bills was highlighted by the media in January. Asked what took the regulator so long to act, a written response e-mailed is reproduced below:

“The SBP has been aware of this recent phenomenon since its beginning and has been dealing with banks/exchange companies individually against whom complaints were made.

Nervous citizens took the preference of commercial banks for new dollar bills as a signal of the old ones going out of circulation

“With the growing number of incidences, the SBP has taken cognisance of the issue at a broader level and made clear to banks that there is no room for quoting different exchange rates for old and new design US dollar currency notes. In case of violation, the SBP may take strict regulatory action against the involved bank or exchange company”.

It is hard to say what triggered the cycle or when but in late Dec 2016 amid heightened dollar demand and post Trump victory in the US, rumours about redundancy of the old design $100 notes started circulating.

Nervous citizens took the preference of commercial banks for new dollar bills as a signal of the old ones going out of circulation. This led to a run on money changers who started ramping up the selling rate for the new dollar bill and pulling down the buying rate for the old design $100 notes.

The depressed exchange rate for old dollar notes has hurt ordinary households who exchanged them for local currency. Many middle class Pakistani households store some savings in dollars to maintain a baseline value against rupee depreciation. The worst impact, however, was borne quietly by dollar hoarders of ill-gotten wealth.

They tried secretly to salvage the value of wades of $100 bills and accepted the loss as a fait accompli. According to an estimate this segment lost, on an average, about 10pc of the value of old design dollars owing to market manipulation.

“Initially I was enraged at the price of the dollar quoted by my currency agent. Soon I realised that it would be wise to endure some loss to avoid a bigger one later. I managed to exchange all of my old notes but after I accepted the rate (Rs100 to a dollar) quoted”, a retired income tax officer from Lahore said.

According to anecdotal evidence money changers pocketed 10-20pc of the market value of old design dollar notes that reached them during the episode.

The margin of the individual dealer depended on his assessment of the degree of vulnerability of the client approaching them with requests, a stock broker also dealing in currency said.

“Money changers, particularly unlicensed ones, made the most out of this. There is no evidence to implicate the government in the old/new dollar episode but it did save them the embarrassment of rupee depreciation”, commented a mutual fund operator.

Most bankers contacted were reluctant to comment.

“In a parallel economy as big as ours it is not easy to accurately trace factors behind market volatility. Sometimes rumours trigger a cycle of reaction leading to market aberrations”, said a senior banker.

Malik Bostan, Chairman, Exchange Companies Association, blamed commercial banks for the fiasco. “How can they refuse a legal tender? But they do all the time. We are intermediaries and pass notes that we receive”.

“We do export foreign currency stocks to Dubai to our sister companies there but only after authorisation from the State Bank. The operation involves physical cost and time”, Bostan said justifying the spread between the official and market rates for currencies.

He insisted that licensed companies operate within legal confines and suspected unlicensed operators of mischief. “In January, according to our estimates, the demand for dollar in the kerb market was of $5-8m against the supply of $2-3m. How can our members be blamed if the dollar rate started climbing?” he defended his sector.

A respected retired banker was caught unawares when reached over phone for his comment.

He said, “the US had not demonetised any currency note in over 100 years. It did introduce advance security in a new series. People who park savings in dollars ought to know this”.

Three points emerged from the market as key factors for creating the situation: First, the thought that after the sudden demonetisation in India, the same can be repeated by other governments.

Second, an erratic and unpredictable Trump could do anything at will; and third, the low credibility of the government regarding dollars, recalled by the foreign currency account freeze of 1998.

Published in Dawn, Economic & Business, February 27th, 2017