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THE recent fall of the US dollar has once again showed that the market is vulnerable to all sorts of speculations. The dollar declined by 4.5 per cent within first two days of the week ending on October 6, before it started to regain part of its lost strength.
The reasons for this steep fall have been extensively debated in the newspapers but one thing that stands out is: There emerged an anti-dollar sentiment among the holders of this hard currency. They started selling greenbacks fearing that it could fall further. This panic-selling kept the dollar on the decline that, in turn, created more uncertainty about its strength, resulting in more selling. Thus a cycle of self-fulfilling prophecy took full round.
Open currency markets across the globe do respond to speculations and self-fulfilling prophecies remain at work with varying degrees of intensity. But in a country like Pakistan that needs to borrow from outside even to retire its debts, a volatile open currency market can be very dangerous as it turned out to be last week. When the dollar started falling not because of any changes in the economic fundamentals but purely on speculations, this had a direct bearing also on the inter-bank foreign exchange market.
The dollar shed 2.3 per cent of its value in the inter-bank market within first two days of the week ending on October 6 before it started to bounce back. This huge depreciation in the dollar value, and that too in a matter of two days, shocked the exporters and they called upon the State Bank to take note of it. The SBP officials, who were celebrating the rise of the rupee, did realize that it was time for them to keep the dollar from falling further. They did two things: Lowered the yield on the three-month Treasury bills by 18 basis points to keep the inter-bank money market ‘reasonably liquid’ and also silently purchased a couple of millions of dollars from the banks to help it recover some strength. But they refrained from making a direct intervention in the foreign exchange market for they knew that this would send a wrong signal. The central bank only wanted to indicate that banks should not fall prey to speculative forces at work in the open currency market: They should let the dollar-rupee parity be determined by active interaction of the market forces i.e. the real supply and the demand. The SBP officials responsible for managing the foreign exchange market even told banks that they should not desist from dollar-buying on fears of further fall in its value. They also assured them that if the inter-bank market fell short of dollars the State Bank would supply the same.
There are a couple of lessons for all the market players in Pakistan in the way the inter-bank and open currency markets behaved during the past week.
1. MISCONCEPTIONS ABOUT KERB MARKET SHOULD BE REMOVED: It is the responsibility of the State Bank to remove the misconceptions about the kerb market so that people in general, and banks and other players of the financial markets in particular, do not fall prey to the vagaries of kerb trading. In the recent past, the SBP had prepared a comprehensive report on the kerb market, its constituents and players, sources of inflow and avenues of outflows, and share of various groups in kerb buying and selling. That report, insiders say, has established that only seven per cent of the total volume traded on the kerb market relates to the household sector-small investors who keep part of their savings in dollars to offset the erosion in the rupee value. The remaining 93 per cent change hands through the overseas Pakistanis, importers and exporters, the Afghan transit traders, drug-pushers, smugglers, money launders and currency speculators many of whom operate as money changers. The report has also established that Dubai is the hub of all the big players involved in the currency exchange business. The report says that these hundiwallas take the bulk of the home remittances by offering faster services and better price, leaving very little for the banks to do. The result is that out of an estimated $7-$8 billion inflow from 3.5 million Pakistanis working abroad only $1 billion comes through the banking channels and the rest through hundi.
People are generally not aware of all this. They don’t know who actually is selling or buying the dollar in the open market. When the dollar goes down, as was the case during the last week, people start panic-selling for they believe that others are also selling dollars to avoid losses. But they do not realize into which category of sellers do they fall. Or when the dollar moves up, as is normally the case, people start buying for they believe that others are also out to buy to contain the erosion in the rupee value. Again, they do not realize into which class do they fall. Quite often the big money changers set the tone of the market by booking big purchases or sales among themselves, without the deal really materializing, and then spread word among smaller money changers that the dollar is moving up or falling down. People have little idea about how mysterious is the world of money changers: Some 400 of them have got work license from the State Bank but very few submit any returns of their business as required under the terms of the license. The State Bank is now working on a plan to let these money changers set upforeign exchange companies with much larger capitals and allow them to handle official home remittances at a nominal fee.
The idea is to reduce the number of money changers operating under the license of the SBP on the one hand and to tap as much of $7-$8 billion of home remittances as is possible. The central bankers say supervising the work of a dozen or so big foreign exchange companies would be much easier than to look after 400 outlets of currency dealers — some housed in 4X4 feet kiosks and manned by semi-literate young chaps. The earlier it is done the better it would be.
A big misconception about the open currency market is about the volume traded there. The reality is that not more than $3 million change hands in the open market in a day-but the amount transacted in the inter-bank market is ten times higher.
There is, therefore, not much point for the banks and the businessmen to make assessments about the future health of the rupee on the basis of the exchange rate movements in the open market. People in general must also know that the exchange rate prevailing at a given point of time in the kerb market is not reflective of the real strength of the local currency.
The SBP can remove these and several other misconceptions about the kerb market by making public the above-mentioned report, or the latest version of it, or even a new report that covers all important aspects of the open currency market operations.
2. INFLUENCE OF THE KERB MARKET ON INTER-BANK MARKET MUST BE CURTAILED: Lately the State Bank has taken many measures under the IMF-sponsored programme to liberalize the foreign exchange market that has reduced the influence of the kerb market on the inter-bank market. In fact, the SBP has shown in one of its previous quarterly reports that it is the inter-bank market that impacts on the kerb market. But occasionally, the volatility of the kerb market still creeps in the inter-bank market as is evident from the movements in the exchange rates last week. The SBP officials responsible for overseeing the inter-bank foreign exchange market on day-to-day basis must enhance their skills to ensure that the bankers work in their own sphere without being tempted to get clues from the open currency market and act on them. But in so doing the SBP should take into confidence all the active market players instead of trying to regulate them arbitrarily.
3. DOLLAR SWAP WINDOW SHOULD BE ESTABLISHED: The dramatic fall of the dollar last week has only highlighted the need for setting up a permanent dollar swap window at the State Bank. The SBP can use this window to inject in, or mop up dollars from the inter-bank market as the case may be without making a direct intervention. The dollar swap window can be extremely helpful in managing cash flows in the inter-bank money market and building an inventory of dollars for debt payments or for other purposes for a specific period. But here again, the SBP should seek cooperation of all the banks in setting up this facility like it did while introducing KIBOR i.e. Karachi Inter-bank Offered Rates last month. The creation of the dollar swap window will also reduce the SBP’s reliance on the open market for buying dollars at the time of need. That, in turn, will reduce the financial losses that the SBP incurs by paying a higher price for the dollars bought from the open currency market. This does not mean that setting up a dollar swap window will eliminate the need to make outright purchases from the kerb market but it will certainly lessen it. Besides, it will also force the money changers to narrow the spread between the inter-bank and the open market exchange rates.
4. EXPORTERS SHOULD NOT HOLD DOLLARS FOR PROFIT TAKING: The job of the exporters is to earn foreign exchange for them and for the country. When they start holding export dollars for profit taking it hits the rupee hard. Such exporters do not realize that this may earn them a couple of millions of extra rupees but eventually it distorts the market that warrants corrective measures from the State Bank. And that in turn, often results in hiking of the SBP discount rates and the T-bills rate thereby making export finance and normal working capital expensive for them.
On some occasions, like the one in the last week, the exporters holding dollars for profit taking have to sell in hurry and in panic and book losses. Besides, when exporters hold export dollars for too long, and the rupee depreciates too much, some of them start panic-selling believing that the dollar has reached its peak and now it is bound to fall. That again causes heavy losses to those who cannot make timely and wise moves. So it is better for the exporters to stay away from currency speculation and work hard for enhancing exports.
5. IMPORTERS SHOULD NOT RUSH ON BOOKING FORWARD DOLLAR: Whereas holding of export-dollars results in lower supply, panic- buying by importers increases the demand for the greenback. And when the two coincide, and quite often they do, then the dollar progresses by leaps and bounds. The State Bank with its small foreign exchange reserves has to watch helplessly the fall of the rupee from the sidelines. It cannot make a direct intervention at such occasions solely because when the anti-rupee sentiment is at work it is ready to devour any amount of dollar injection. Besides, when Pakistan is under an IMF programme, the SBP is advised to manage the exchange rates through changes in the monetary policy and not through interventions. Admitted that the importers need to hedge their positions against future fluctuations in the exchange rates, but making a beeline for dollars every time is short in supply, is not the right thing to do. People in the foreign exchange market know there are many importers out there whose job it is to buy a couple of millions of dollars, or just start making queries for that, when the dollar moves up. Similarly there are exporters, who stop selling immediately after the dollar start coming down. Such importers as well as exporters work in league with their bankers who make big profits by keeping the exporters at bay and encouraging the importers to make a beeline at the bank counters. The dramatic fall of the dollar last week must also serve as a lesson to such bankers many of whom did not know that the dollar would start throwing off its value immediately at the start of the second quarter. They were rather holding dollars to earn windfalls at the end of the first quarter in September anticipating that the quarter-end official and private debt payments would certainly make the dollar expensive. But thanks to some rescheduling of the debt and due to the dramatic developments that took place immediately after the September 11 terror attacks on New York and Washington, Pakistan met all the external foreign exchange obligations without difficulty and the dollar showed no spike.
