The representatives of ECs made it clear that their companies were not responsible for rupee's slide, adding that dollar was soaring because of interbank market where panic buying was being witnessed due to high level of forward trading for Letters of Credit (LCs). "Usually, the open market follows the interbank market and any change in the interbank market will directly affect the open market exchange rate," they asserted.
So far as action to arrest the depreciating trend in PKR was concerned, the ECs urged upon the SBP to take steps to stop smuggling of the currency, which was illegally being exported to other countries, particularly to Dubai. According to the Chairman of Exchange Companies Association of Pakistan, Malik Bostan, "at least $5-7 million is smuggled out. We used to receive $10-12 million per day, now we receive in the range of $5-7 million per day, reflecting a large volume of smuggling." The SBP was advised to request the UAE government for strict vigilance of official remittances and currency export should not be allowed without SBP's declaration. The State Bank was also asked to monitor certain banks which had formed a cartel and were responsible for the abrupt increase in dollar price.
Proceedings of that meeting as reported by the media do not inspire the confidence that the State Bank has a sound understanding of the current exchange rate management of the country; nor does it provide answer to a profound question whether the central bank is equipped with the necessary wherewithal to stem the tide of rupee depreciation. In a free floating exchange rate regime as adopted by Pakistan, the value of a country's currency is determined entirely by market forces viz: at an equilibrium rate determined by the level of supply and demand at a particular point of time. There is no need to go into the details of sources of supply or demand factors of a currency because of their obviousness but if at any time a central bank apprehends that the rate of its currency is being manipulated by speculators to make undue profits, it could always buy and sell the foreign currency to smooth out excessive fluctuations.
We don't believe that the State Bank does not have a strong appreciation of this simple principle and is as naïve as to think that the ECs could make a significant contribution to affect the exchange rate of the rupee in one way or the other. What it could easily do to discourage the speculative forces and check the slide of the rupee in the short run was to inject enough amount of dollars in the interbank market and it did inject 40 million dollars yesterday but such an option does not seem to be sufficiently available due to dwindling level of foreign exchange reserves at its disposal. State Bank's intervention helped the PKR to recover somewhat on 18th December but such a recovery cannot be longer lasting until and unless the supply of foreign exchange matches the growing demand and the country is able to accumulate enough foreign exchange reserves to defend a particular rupee rate.
Unfortunately, however, net capital inflows have declined to the negative range, current account was in deficit by dollar 365 million in July-November, 2012 and huge payments have to be made to the IMF in the next few months. In short, all the indications are that foreign exchange reserves of the country would fall to dangerously low levels in about a year's time, barring some extraordinary positive developments. Another important factor eroding the value of the Pak rupee is much higher inflation in the country compared to the rest of the world. The rupee rate cannot be expected to stabilise or strengthen if the currency is fast losing its purchasing power. Finally, the SBP is itself responsible for pushing the rupee rate down by reducing its policy rate by 400 basis points in a relatively short period of time and making the foreign currency-denominated assets more attractive than those denominated by rupee.
Such a policy increases the demand for foreign currency and encourages capital outflows. The State Bank needs to take into account the totality of picture and make the required practical moves, with the support of other stakeholders including the government, accordingly to reverse PKR's deteriorating trend. In particular, enough supply of foreign currency has to be ensured in the market by enhancing the level of exports and attracting higher amount of FDI and other financial inflows. By seeking the help of ECs, the SBP is missing the point altogether and betting on wrong horses. Such a plea, in fact, could be counterproductive and send a wrong message across the market about central bank's ability to help provide protection to a vulnerable rupee from the onslaught of speculative forces.