KARACHI, Dec 25: At the end of November 2004, all local and foreign banks working in Pakistan had $3 billion fresh foreign currency deposits i.e. those generated afresh after the freezing of $11 billion deposits in May 1998 when the country had gone nuclear.

Data released by the State Bank show that the stock of fresh foreign currency deposits rose to $3.009 billion at the end of November from $2.671 billion at the end of June, depicting an increase of $338 million or 12.6 per cent in the first five months of this fiscal year.

This pace of increase in foreign currency deposits is much faster than seen in the last fiscal year, when these deposits had grown by $375 million or 16.3 per cent during the entire year. The rupee had depreciated by 3.7 per cent during the last fiscal year whereas it lost 2.8 per cent value in the first five months of this fiscal year. With the rupee having been on a gradual recovery path since November 1, growth in foreign currency deposits should decelerate provided the market is convinced that the recovery would continue.

But since this recovery is rooted in the fact that State Bank has been selling dollars to the banks from November 1 to help them finance oil import bill of their clients, the market seems to have ignored the rupee recovery. This is evident from the fact that foreign currency deposits grew by $69 million in November alone, despite the fact that the rupee recovered 2.7 per cent value during that month, after having lost 5.5 per cent value against the dollar between July-October 2004.

What seems to have led people and companies keep increasing their foreign currency deposits is that they fear that the rupee would again start falling once the SBP stops selling dollars for oil imports. When the central bank would discontinue this would depend on how fast Pakistan taps new sources of foreign exchange inflows or to which extent the SBP is ready to let foreign exchange reserves fall. Pakistan's forex reserves fell to $11.522 billion as on December 18 from $12.253 billion at the beginning of last month when the SBP started financing oil imports.

More importantly, the reserves held by the central bank have fallen to $8.804 billion from $9.778 billion during this period. The SBP reserves have declined so sharply not only due to its dollar selling for oil imports but also on payments of government debt as well as import of wheat and fertilizer through state-run agencies. If the central bank's reserves continue to fall at the same pace, it would be difficult for the SBP to keep selling dollars for oil imports.

The fact that the trade deficit has shot up to $2.511 billion within July-November 2004, from just $444 million in a year-ago period also suggests that overall balance of payment would be hurt, foreign exchange reserves would fall further particularly the reserves held by the central bank and the rupee would weaken.

But, if the government raises say $1bn-$2bn through its Islamic and eurobonds, exports grow faster after the lifting of the textile quotas from January, foreign investment moves up and Pakistanis living abroad send back home additional foreign exchange, the situation may not be that bleak. Timing is important. Delays in realizing such possibilities would be dangerous. Once some real additional inflow of foreign exchange is seen through any of the above-listed channels, this would fan pro-rupee sentiments but if there are no signs of real additional inflows, people and companies would start anticipating the fall in the rupee value. This anticipation would set in motion a self-fulfilling prophecy cycle leading to an actual weakening of the rupee.

Internationally the US dollar, the currency in which Pakistan's two-third external trade is denominated, has been losing new grounds against the euro and pound sterling. If the dollar remains on the sliding path also in January-December 2005, this would neutralise Pakistan-specific pro-dollar sentiments in case the country's balance of payments deteriorate. But this neutralization of sentiment would be just psychological and would thus, help keep the rupee stable only to some extent.

On the other hand, if the dollar rebounds next year, Pakistan would find it even more difficult to keep the rupee as much stable as possible i.e. in case it does not witness a net additional inflow of foreign exchange.

The pace with which imports are growing suggests that it would be very difficult, if not impossible, for Pakistan to see a net improvement in balance of payments. Imports during July-November 2004 rose by 49 per cent to $7.882 billion whereas exports grew by just 11 per cent to $5.37 billion.

So, if the rupee weakens in the second half of this fiscal year, people and companies would naturally be tempted to increase their stock of foreign currency deposits. That seems a real possibility also because internationally interest rates have been on the rise. But if the rupee remains stable, then foreign currency deposits may not grow too fast.