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ALMOST everywhere I go these days, there is one question that props up: is the rupee about to be devalued? This is one of the signs that an exchange rate adjustment is coming, and if you are asking yourself the same question, for whatever reason, you can be reasonably sure that just about everyone else is too.

Feeding the growing anxiety around the exchange rate is the fate of Mr Dar, the finance minister. He has been known as a staunch supporter of keeping the rupee where it is, arguing that if the country is losing reserves through the current account deficit, it is replenishing them through other means.

“You need dollars to keep the exchange rate steady?” he once angrily asked the State Bank following his meeting with bank presidents after the short-lived devaluation back in July. “We are bringing you those dollars!”

Mr Dar could shout down the State Bank and presidents of Pakistan’s myriad banks. But he cannot shout down the market.

His point was that if the government is maintaining dollar inflows, then why all this talk about dollar outflows through the current account deficit? Mr Dar could shout down the State Bank and presidents of Pakistan’s myriad banks with this logic. But he cannot shout down the market.

The market is asking itself this question with increasing anxiety these days. Not only that, it is basing some business decisions on it. For example, many importers start selling their product as soon as the ship carrying it reaches outer anchorage, but now they are holding off till the inventory arrives in their warehouses, in the anticipation that there might be a devaluation in the meantime.

A key indicator of how exchange rate expectations are playing out in the market is in what they call the ‘net open positions’ of banks. When exporters sell their product abroad, they collect the payment in an account in a foreign country. If the sale is made through an LC, they have up to 90 days to bring these funds back to Pakistan, as per State Bank guidelines. If they believe there is going to be a devaluation they hold off as a long as they can. If they believe the exchange rate will move in the opposite direction, they bring the money back as fast as they can.

Something like this happened in March of 2014, when a low-intensity tussle around the exchange rate had been playing out between the government and exporters. The latter were withholding their proceeds and the net open positions of the banks were bloated. The finance minister first went to an APTMA convention and warned them that the dollar was about to come down, and they would lose money if they did not return their proceeds. Then he went on air and repeated the message, this time adding that he wanted to see the dollar at Rs98.

The exporters thought the minister was bluffing and that the government did not have enough in the reserves to supply the market with dollars sufficient to bring the rupee to the level the minister wanted it at. Then suddenly $750 million arrived in the reserves, seemingly from nowhere. Just as people were absorbing the implications of this mystery inflow, another $750m arrived. The exporters suddenly realised the minister was not bluffing after all, and they all rushed to close their open positions, creating a massive inflow that by itself drove the rupee down to 98. Mr Dar was mightily pleased.

The State Bank noted the developments at the time, but added a word of caution. Bringing the dollar down was easy enough, it said in its subsequent quarterly report. Keeping it there will be the real challenge.

The government managed that challenge until about October 2016, when the reserves peaked and began their downward trajectory, which has continued ever since at an accelerating pace. Now some advance signs are emerging that the glory days will be over soon, but nobody can figure out how soon.

This is a dangerous place to be at. The uncertainty and anxiety appears to be seeping into real life business decisions, although more data on the open positions being maintained by exporters, as well as the quantum of demand coming from importers are important to know determine how deep the anxiety has penetrated into the business life of the economy.

The danger is that with the passing of time, if the reserve decline does not arrest itself, the anxiety can grow into panic. If these sentiments spill over, and we see growing dollarisation (some early signs already point towards this, although they are inconclusive), that could in turn become capital flight. At least that’s how it worked in 2008, which was a balance of payments crisis of nearly epic proportions, the likes of which this country has seen on only a few occasions in the past, such as 1998 in the aftermath of the nuclear detonations and the freezing of the foreign currency accounts.

This time things are unlikely to be that pronounced. Despite the hype, nothing happening around us is nearly as heavy as the nuclear detonations or the global financial crisis. This time it’s likely to be a repeat of 2013, when reserves slid to a level that an approach to the IMF became essential, and due to the good will of the superpower, some of the preconditions were softened up. There was no manifest ‘crisis’ as such in 2013, if by crisis we understand a state of affairs whose direct impact is felt by the common citizenry, such as through a freezing of bank accounts, flooring of the stock market, disruption of the oil supply chain, or a sharp spike in inflation.

The exchange rate will adjust to new realities whether or not the government wants it. But exactly when this will happen, and how far it will go, is nearly impossible to tell because too many variables are at play, and not all of them are empirically measurable. Best to buckle in and wait.

The writer is a member of staff.

Twitter: @khurramhusain

Published in Dawn, October 5th, 2017

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