Now this is strange. On the morning of Wednesday, as the broadcast media remained fixated on the appearance of Maryam Nawaz before the JIT, the rupee suddenly started sliding against the dollar. Where it had remained around Rs104.8 to the dollar since the spring of 2014 — and we kept hearing that it is overvalued, how exports are hurting as a result, how currencies of other countries whose exports compete with Pakistan’s have been depreciated in recent years — it stuck stubbornly to that level.
Then suddenly in one morning it slides by 3pc. What on earth happened? We know that the State Bank suddenly stopped intervening in the currency markets on that morning. This gets a little technical so let me explain.
The State Bank has a number of tools through which it can influence the exchange rate, some obvious others subtle. The most obvious tool is to buy and sell dollars from the interbank market. When they want the rupee to rise, for example, they can sell large quantities of dollars to the interbank market, thereby increasing the supply of foreign exchange, and bringing down its price. When they want the rate to fall, they either buy dollars from the market, or simply stop selling, whichever is necessary to constrict the supply and cause the price of the dollar to rise.
As the rupee slid slightly in the morning, treasurers were expecting their phone to ring, and when it didn’t, they grew puzzled.
The problem with this approach is that it is contrary to market principles of exchange rate management, and since we claim to have a market determined exchange rate, regular interventions of this sort will belie that claim, triggering alarm bells at the IMF and causing foreign creditors to become concerned. Each such transaction leaves a trace, and while the country is on an IMF programme, the mission chief sitting in Washington, D.C., can actually see such transactions happening in real time on a dashboard on his screen.
So then there are the more subtle measures. The subtlest of them all is a simple phone call from the State Bank to the treasurers of major banks. As the rate begins to rise and hit an informal ceiling, a phone call will come to the treasurer from the State Bank saying “don’t buy at this level”. The treasurer will obey (it would be foolish not to), and suddenly the price will stabilise wherever the bank wants it to be. The same phone call could also bring instructions to sell dollars on the market, thereby increasing supply but without leaving the fingerprints of the State Bank all over the affair. Again, banks are not legally bound to follow such instructions, but if they know what’s good for them, they will.
This method has the benefit of operating below the radar, meaning it leaves no trace and is not visible to the Fund or other foreign creditors. Hence the currency will appear stable, and there will be no major central bank interventions in the foreign exchange market. The country can then tell its creditors that our exchange rate is market determined, and it is stable, which means our creditworthiness is intact and macro fundamentals are secure.
Phone calls such as these are made on a daily basis. But yesterday these calls never came. As the rupee slid slightly in the morning, treasurers were expecting their phone to ring, and when it didn’t, they grew puzzled. ‘Should we stake out positions based on where the rupee is going? Or should we expect that the bank will want to end the slide shortly?’ they asked themselves.
So they decided to call their counterparts at the State Bank and ask ‘what’s going on?’ The word in banking circles is that they received the following answer “we are under instructions to let the rupee find its own value”. Suddenly the soft supports that had lain below the rupee vanished.
So who issued these instructions? Was it an economic decision made at higher levels within the State Bank? Or was it a political decision, conveyed to the State Bank from Islamabad? The media was connecting its own dots all day, but one thing is obvious: nothing has happened on the economic front to merit such a sudden move in one day. The move was inevitable for almost two years now, and as our exports have floundered and imports continued to rise, it became more and more inevitable.
But usually a move of this sort is preceded by a steady drumbeat of cautious statements, where the government will begin pointing towards a deteriorating situation day by day, eventually sounding caution from the highest levels, which in this case would be the finance minister. We have not seen this though.
If the government wants us to believe that its difficulties with the JIT have caused gyrations in the currency markets, you should know that things don’t work like that. For the longest time, we kept hearing that the sharp stock market declines are due to the prevailing political uncertainty, but those in the know will tell you that even on the trade floor, things don’t work like that. Political uncertainty, especially of this sort, cannot trigger sustained selling pressure.
Likewise if we are going to be told that the currency markets are spooked by the political prospects of the ruling family, it is hogwash. What determines the value of the currency is the supply and demand of foreign exchange in the interbank market, and that fact is linked with political drama unfolding in Islamabad only by the most specious of threads.
Fact is this was an engineered event, and we need to know who the engineer was. By itself a currency depreciation is not a bad thing, and if the rupee remains at the level that it found on Wednesday, it will help rectify a distortion in our external account. Rather than make a big deal of the depreciation itself, it would be better to ask on whose instructions the various supports were pulled away from the rupee.
The writer is a member of staff.
Published in Dawn, July 6th, 2017