Since the beginning of this fiscal year, the interbank foreign exchange market has been operating calmly — thanks to depressed demand for import dollars.

Pakistan’s merchandise import bill has been falling. Banks are now meeting importers’ demand for dollars with relative ease. In the last fiscal year, they had to struggle on a daily basis to finance the import letters of credit of their clients.

The reduction in the average merchandise import bill from $4.56 billion per month in the entire 2018-19 to $3.81bn per month in the first five months of 2019-20 has made the bankers’ job of squaring their daily foreign exchange positions easier.

While trying to meet daily dollar demand with the daily supplies of foreign exchange via exports and remittances etc, banks often have to make a drawdown on their stocks of foreign currency (FCY) deposits. And, sometimes, the central bank has to arrange dollars for them through a handful of central banking tools, including short-term dollar-rupee swaps. Since the beginning of this fiscal year, the State Bank of Pakistan (SBP) has not completely shuttered the swaps window. But it has minimised its intervention in the interbank market to meet some requirements of the ongoing IMF lending programme.

A lower current account deficit has raised the level of interbank foreign exchange liquidity

This should have ideally resulted in increased reliance of banks on their FCY deposits for meeting dollar demand of their clients. But the decline in the import bill has helped banks draw less from FCY deposits despite the fact that they now visit the SBP’s dollar-rupee swap window infrequently.

In 2018-19, the banks’ drawdown on FCY deposits averaged over $588 million per month. But in the first five months of this fiscal year, the monthly average has fallen to less than $517m, recently released SBP data reveals.

Smaller spending on import financing out of FCY deposits has created room for banks to increase pre-shipment and post-shipment foreign exchange spending on exports out of the same deposits. During 2018-19, the banks’ average monthly pre-shipment export financing out of FCY deposits stood at $90.5m. But this average just doubled to $181.2m per month for the five months of this fiscal year. Post-shipment financing out of FCY deposits averaged at $133.8m per month in 2018-19. This monthly average during the first five months of this fiscal year, however, shot up to $152m, data shows.

After facing external-account difficulties in 2017-18 and 2018-19, the country has managed to correct some imbalances during this fiscal year. Most notably, the current account deficit that was at an all-time high of $19.89bn in 2017-18 and was still at $13.83bn in 2018-19 has shrunk. This deficit has come down to just $1.47bn in the first four months of 2019-20 from $5.56bn a year ago.

This development, despite the fact that the overall balance of payment still remains negative by $1.16bn, has raised the level of interbank foreign exchange liquidity. And that, in turn, has emboldened the SBP to allow banks to entertain foreign exchange demand from their clients a bit more liberally.

Such clients include importers of goods and services, foreign companies and foreigners in Pakistan repatriating foreign exchange back home — and Pakistanis requiring foreign exchange for overseas visits or financing educational and medical expenses of their loved ones abroad.

Since mid-November, banks have been making advance import payments at the rate of $10,000 per invoice on behalf of all eligible manufacturing companies instead of just those that also export their products. Similarly, as a token of its growing confidence in foreign exchange liquidity in the interbank market, the SBP has also allowed banks to arrange up to $10,000 to individual or corporate clients for hiring services of foreigners without its prior permission.

However, it would be naïve to conclude from the foregoing that the apparent calm in the interbank market amidst little improvement in foreign exchange supplies can be sustained without further improvement in non-debt creating inflows via exports and remittances. For the time being, the exchange rate is stable and the rupee has regained part of its lost worth against the dollar. The SBP is not intervening in the foreign exchange market. The central bank is also not rolling over previously concluded dollar-rupee swaps that it had transacted in the past for pumping dollars in the interbank market to save the rupee from a free fall in 2018-19.

The rupee was rapidly losing its worth against the dollar in 2018-19. It lost 31.7pc. At that time, the SBP was making a drawdown on foreign exchange reserves to support the rupee. Besides, banks were also indulging in foreign exchange borrowings from abroad to be able to meet dollar demand at home. This has changed in this fiscal year: the central bank is not intervening in the foreign exchange market and banks are also not making net additional foreign exchange borrowing from foreign sources.

The stock of banks’ foreign exchange borrowings from abroad has come down from $3.15bn at the end of June to $2.76bn at the end of October. Meanwhile, their overall FCY deposits have increased from $7.89bn to $8.05bn during this period.

But the current stability in exchange rates with chances of this stability remaining for some time in the future means people and businesses may not feed their FCY deposits as aggressively unlike in the past when the rupee was on the slide.

That can limit the growth of FCY deposits. The rupee is expected to remain stable around the current level of 155 or even rise modestly in the near future owing to the reduction in the current account deficit and a substantial increase in the SBP’s foreign exchange — signs of an improvement in the external account. Reserves surged to an eight-month high of $10.41bn after the recent inflow of a $1.3bn loan from Asian Development Bank.

Published in Dawn, The Business and Finance Weekly, December 16th, 2019