The forex market is confused. From bank treasurers and dealers in the interbank market to owners and operators of forex companies, all are uncertain about the future of the rupee.

“We don’t know exactly when we’ll get a reliable clue on exchange rates from policymakers. But market fundamentals suggest the rupee is being pampered. The forex market doesn’t know and cannot know when this pampering will be over,” said owner of a big Karachi-based forex company.

“By the end of this quarter, things may become clear. But so far the interbank market is also confused. The dollar is in short supply, the rupee is overvalued, but the central bank is defending the exchange rate at the current level,” said the treasurer of a large local bank.

The July 28 ouster of Nawaz Sharif from the office of the prime minister has added to the forex market confusion that began on July 5.

On that day the State Bank of Pakistan (SBP) allowed 3.1pc depreciation in rupee’s value but Finance Minister Ishaq Dar, who has retained the post in the newly formed cabinet, intervened and asked the SBP to help the local currency recover its lost ground. The rupee, consequently, gained a large part of its lost value immediately.

“Even then, the market was bewildered. It was difficult for us to digest how a central bank can eat its words,” recalls the treasurer of another large local bank referring to the fact that the SBP had owned the July 5 move through an official statement.

“By the end of this quarter, things may become clear. But so far the interbank market is also confused,” a banker says

A new permanent governor of the SBP was inducted, replacing the acting governor, who had approved of the July 5 action.

“In his first meeting with heads of the bank, the new governor spelled out his priorities but avoided detailing us on why the July 5 move was inappropriate and whether the reversal of the one-time depreciation meant no immediate threat of a fall in the rupee’s value,” recalled a source privy to that meeting.

In spite of this confusion, forex markets continued to operate keeping in mind that at least for the time being the SBP would not let the rupee fall again regardless of growing evidence of its overvaluation and the weaknesses in the external sector account.

“Banks had not bought the argument that there was no case of a rupee depreciation. On the contrary, most of us knew that the rupee had been put in an oxygen tent because the [then] government had so desired,” recounts a senior executive of a foreign bank.

But the July 28 episode once again jolted the rupee — not in the interbank market that was under strict SBP vigilance — but in the open market where the rupee shed 2pc in a single day and touched the level it had already fallen to in response to the July 5 depreciation.

“Again, the SBP sprang into action and asked forex companies to keep the rupee stable. ‘Bring it back to where it was before July 28’ was the instruction for us,” says the owner of a local forex company.

Exchange rates being quoted on forex companies’ screen boards changed overnight and the rupee ‘regained’ a large part of its lost ground. But while this happened, activity in the open market came to a near halt.

“No one was willing to sell dollars at the new rate (Rs107 a dollar) after the market rate had shot up to Rs109 on the day Nawaz had gone,” he says.

In the interbank market, the rupee closed at Rs105.40 per dollar on July 3, down 0.5pc from Rs104.90 per dollar on July 4.

“It seems the SBP is letting the rupee fall gradually but the pace is too slow. When this gradual depreciation picks up pace and the rupee is allowed to fall again to Rs108.24 a dollar (the level it touched on July 5) is anybody’s guess,” says chief forex dealer at a local bank.

“That the central bank is behind this temporary stability in exchange rate has now become evident from a continuous fall in its forex reserves,” he says.

The SBP’s forex reserves fell from $16.197bn as on July 7 to $15.478bn on July 14 to $15bn on July 21 and finally to $14.698bn on July 28. A plunge of $1.5bn in just three weeks is enough indication that the SBP is defending the rupee (by taking a hit on the reserves to make up for the short supply of dollars in the market), senior bankers say.

“But since the central bank would not like to be seen as a net seller of foreign exchange in the market (as this shall provide a clear clue to international financial institutions of the central bank’s intention to keep the rupee artificially high), we expect that towards the quarter-end the rupee will once again come under severe pressure,” says a local bank’s treasurer.

But some bankers say that since the forward premiums on the dollar have not seen any big rise in the last four weeks, one cannot say bankers are actually expecting any substantial downward pressure on the rupee.

Up till a few years ago, forward premiums used to shoot up whenever the interbank market anticipated a decline in the rupee’s value. But much of the rise in premiums used to originate from unreal dollar buying pressure of importers.

Now, due to stricter SBP regulations it is simply too difficult for banks and importers to connive and create an impression of a big demand for dollars.

Only real future requirements of importers are taken into consideration before quoting forward premiums on dollar. That keeps any artificial dollar buying pressure from building up, senior bankers say.

Currently, the SBP is also pushing banks to speed up realisation of export proceeds to ease pressure on dollar demand. But the backlog of unrealised export proceeds is not so huge.

Even if it is cleared up immediately it cannot boost dollar supply to match big demand which keeps growing bigger because of the ballooning current account deficit.

In FY17, the deficit reached $12bn from just $4.867bn in FY16.

If exports don’t rise dramatically and if remittances keep falling, the current account deficit may remain quite high during this quarter. This would make it too difficult for the central bank to defend the exchange rate at the present level may, particularly in the wake of the ongoing decline in its forex reserves, senior bankers warn.

Published in Dawn, The Business and Finance Weekly, August 7th, 2017