It's SBP's job to defend PKR

Monday Jan 17, 2012

Following a turbulent and nervous start of the week that pushed Rupee to a new all-time low of 91.33 against US Dollar, some stability was witnessed in the interbank market at the end of the week.

That stability, albeit weak, nevertheless owed its existence to a timely SBP intervention, which was later followed by a slash in banks' NOSTRO and Net Open Position (NOP) limits.

About half a dozen banks faced a slash in their limits to reduce foreign currency holdings.
Some reports are suggesting that the SBP auditors made some hectic moves to examine banks' treasury deals with a view to ascertaining there are no irregularities.

With external flows queuing up, drying up of foreign inflows and widening of a trade gap due to falling exports and rising imports and no news on IMF front, Pakistan's exchange rate is also under a severe pressure.

The situation gives birth to some legitimate fears of a negative balance of payment (BoP) position.
The SBP Governor's recent briefing to Senate's Standing Committee expressing his concerns on the state of economy further dented the Rupee, although he rightly pointed out that the fall in net capital and financial inflow during the last 5 months is a matter of grave concern, which could escalate current account deficit and that there is likelihood of a sharp fall in foreign exchange reserves.
But matters pertaining to foreign exchange reserves and currencies are never discussed so openly to discourage speculative moves, as monetary management is purely Central Bank's preserve or responsibility, which makes it immune from offering any explanation on the subject.
Deteriorating global economic conditions are putting a lot of pressure on deficit economies that is exerting pressure on currencies, which is bad news for Pak Rupee too.
The country's Central Bank should prepare a contingency plan and take proactive measures to minimise such moves in future.

Last week's downgrading of 9-Euro-zone countries should be taken quite seriously.

Pakistan's deteriorating economic conditions are a matter of grave concern and the risk is that rating agencies may lose no time in initiating action if the country's economic behaviour does not improve.

Further, a downgrade would mean a costly affair, making access to get new funds more difficult.
There are many factors responsible for economic difficulties faced by the country for which SBP is not solely responsible.

But in real sense of the word, there are quite a few loopholes that need to be plugged by the SBP, which can bring some stability and confidence in the foreign exchange market, as signs are imminent that economic recovery in Pakistan will not happen anytime soon and if SBP pays no heed, PKR will surely get a painful hit.
For the last 3 to 4 months, interbank foreign exchange market has been witnessing some volatile market conditions - a phenomenon not strictly caused by speculation.

The two-way currency move was based on demand and supply caused by a slowdown in inflows after Ramzan and Eid that saw a drop in remittances, and export receivables.

Moreover, oil payments piled up.

Widening of trade gap and a stronger US Dollar against global currencies dented the Rupee value.
It was last-hour buying by a major Islamic bank to get rid of its Rupee holdings that caused a bigger damage to the Rupee against USD.

This has been going on for quite some time until SBP realised the existence of that problem and initiated an action against the bank.

In short span of time, Sukuk jumped from Rs 11 billion to current Rs 282 billion and yet, Islamic banks instead of getting hold of Sukuk from the market have been found chasing US Dollar.

SBP is therefore required to take stock of the situation as it frequently talks of developing a corporate debt market.

No holder will offer Sukuk at purchase price; bidders will have to make attractive offer.
Unfortunately, however, the real culprit (Islamic bank) made its escape good after a mild punishment, but four to six banks that were buying USD to cover their positions or utilising their limits had to appear before the Central Bank to explain why that had been making USD purchases.
Commercial banks are complaining that the SBP is making frequent calls on a daily basis, asking banks to explain in detail about their Dollar buying.

If banks are found to be in breaching their lawful limits they should be penalised.

If they are transacting within the prescribed - not prescribed - limits the SBP absolutely has no right to question commercial banks' foreign exchange transactions.

If the SBP is facing a difficulty then it should slash the limit by a bigger margin to halt Dollar purchase by banks and provide them the required funds.
This is how every bank is supposed to operate and utilise its NOSTRO/Net Open Position (NOP).

Prior to a slash of limits of few banks, the total NOP limit of the market was Rs 35.5 billion, which in US Dollar terms is roughly 393 million.

Banks do not hold half of the amount in NOSTRO to avoid a possible exchange loss.
After the recent enquiry and explanation, the biggest hurdle for a commercial bank is to quote price to its customer.

How can a bank cover its oil payment of USD 50 million without a strategy, which could be either 25 percent or 50 percent of the advance purchase of USD within its allowed limits in anticipation of payment.

Or, the remaining should be covered after concluding a deal?
Normal practice is that importer/exporter approaches two or three banks to obtain the best price before concluding a deal.

If a bank runs for the cover, buy/sell after the acceptance of rate by a customer then that bank gets cornered as the market becomes aware of the deal.

It is, therefore, important to understand that Pakistan's interbank Fx market is not liquid in Dollar terms and the SBP is a major purchaser of USD from the interbank market, which puts pressure on exchange rate on big ticket deals.

Roughly, the country purchases oil worth USD 275 million on a weekly basis.

Therefore, a Dollar-buying bank is always at the receiving end due to illiquid market conditions.
The central bank is required to seriously consider its present approach towards interbank market.

Instead of moving ahead, interbank market is moving in a reverse direction as it has gone back to the old era.

Trading activity in the interbank foreign exchange and money market is at the lowest ebb because of SBP's regular buying of US Dollars directly from commercial banks and with the introduction of a interest rate corridor.
Though exchange rate moves will largely depend on country's current account position and unless Pakistan maintains a surplus position, pressure on Rupee will remain.
However, there are many exposed areas that are required to be plugged by making an effective use of SBP's monetary tools that could bring some stability in the market.
Despite a tighter monetary policy stance in the last couple of weeks, banks have often approached the SBP window to avail floor facility.

It is a widely known fact that when the currency is under pressure interest rates are kept tight to ease pressure on the currency.

Our Central Bank is in a fix as it has been injecting liquidity since ages to provide funds to banks to buy Government securities.

There is always an end to everything as nothing is forever.

So are we having the last laugh?
Similarly, when the purchase of US Dollar from the market continues it injects Rupee liquidity in a tighter condition, which is in negation of a tighter monetary policy stance, although the SBP may call both the transactions as sheer sterilisation to escape criticism on its policy.
It is urgently required to remove the interest rate corridor, which may look healthier on paper; and it may be easier for banks to place excess funds and borrow when short.

But this has a nuisance value; it is not productive as it is one of the major causes of failure of debt market in Pakistan.

Once interest rate corridor is removed banks will be forced to become active in government paper as well as in corporate debt instruments.
Another major factor that has distorted the interbank market activity is absence of restrictions on late settlement of Rupee transaction after the introduction of Real Time Gross Settlement (RTGS).

The purpose of RTGS was to improve the payment system, but late settlement has allowed banks to trade against Rupee/Dollar for longer hours for same day settlement.
Money market activity received a further dent as SBP for its own comfort and balancing of its book allowed the late Rupee settlement.

Banks can trade long or short Rupee in late hours that has almost killed the interbank trading activity as bank since noon show little or no appetite in Rupee activity and wait for branch reporting knowing well that the SBP window is available to them 24/7.
The real difference between then and now is that previous cut-off time was 1.30pm and then banks had to square their books before it gets too late to avoid Central Bank's admonition.

So banks were compelled to cover their position and square both the books to cover their NOSTRO and Rupee position.

This is unsettling and deteriorating the interbank market.
SBP should ask banks to maintain average on a daily basis instead of a weekly arrangement.

This will bring banks back on their toes as they have increasingly become complacent due to perverse comforting environment provided to them by the central bank.
If banks are speculating, SBP can cut banks' NOSTRO & NOP limits, which may not provide adequate space to banks to hold Dollars.

For lumpy payments, banks should be given approval in advance to breach bank limit to an extent that allows purchase of USD from the interbank market to cover their position.
Most importantly, the market is questioning SBP's buying/purchasing of US Dollar against Pak Rupee.

It is now the credibility factor, which is bothering the market.

Banks' dealing rooms are of view that the Central Bank's approach is questionable because of its past and present association with banks and their colleagues.
For credibility sake, healthier market environment and transparency and stability in the interbank foreign exchange and money market, the SBP can make the best use of some reputed brokerage houses by acquiring their services to buy/sell or intervene in the interbank foreign exchange market.

Outlook 2012 - Growth is SBP's Responsibility

Tuedsay, January 03 2011

After a difficult and bumpy ride in 2011, Pakistan's monetary and fiscal challenges for the 2012 are numerous, with fewer opportunities.

Deteriorating domestic economic conditions will be bad for the economy and may put further pressure on Pak Rupee that could lose another 10-12 percent of its value in 2012 unless the economy manages to show unexpected prowess and the country manages to obtain foreign funding.

Apart from inflation and fiscal deficit, the present government's biggest worry is continued low economic growth that has caused a rise in poverty and joblessness, debt financing, foreign currency liquidity constraints, rising circular debt and possibly growing risk that the country may face a negative balance of payment (BoP).

Remittances are the only area of hope, which would once again do well due to the Arab Spring as the Middle East is the largest contributor.

Rising trend of global remittances further suggests that the inflow of remittances is expected to grow by 5-7 percent annually.

But meeting exports target (volume) could be a difficult task, which fell in the last fiscal year (July-June) due to soft rice and sugar prices in the international market.

The increase in export earnings was due to a rise in global commodity prices, which in real terms means that Pakistan missed out an opportunity to increase export earnings because of a shortfall in export volumes.

Current challenges faced by the export sector are unfavourable domestic market conditions due to high energy prices and energy shortages.

High borrowing cost due to SBP's continued tighter stance and political uncertainty are also hindering business growth.

Why do we complain that growth prospects are very few, foreign investments have dried up, exports cannot flourish due to energy shortages and corruption? Did we ever try to identify or address the real cause? Is there any serious effort to rectify the problems? Are we sensing that urgency to address the issue immediately? Are we aware of some debilitating economic consequences of this delay?

It is the central bank's responsibility to sense the urgency and to foster environment conducive to growth to stimulate the economy by creating new job opportunities in the private sector.

Leave aside the inflation worry, which is globally considered a secondary issue; growth is the first choice preference to correct the economy.

The nation is facing a severe stagnation period.

In such conditions, it makes more sense to create new jobs rather than promote an environment or a situation in which there are no jobs.

Efforts aimed at trying to contain inflation for years do not make a greater sense.

SBP's tight monetary policy stance is not working as an effective tool of discipline.

The central bank is required to contribute towards economic shortcomings by bringing major changes in its policy stance and take proactive measures to correct the deteriorating economic conditions.

There is an urgency to mend things and it is SBP's responsibility to create a conducive environment for growth.

Growth is purely SBP's responsibility; it has nothing to do with the fiscal policy.

Clearly fundamentals are bad and policy is terrible.

The biggest indicator to keep a check on the cause behind a decline in GDP growth is scheduled banks' deposit/advance data.

If we look at the SBP's scheduled banks' past five years deposit growth profile, it has jumped by Rs 2.6 trillion to Rs 5.415 trillion and during the same period banks' advances have gone up by a mere Rs 947 billion to Rs 3.357 trillion, which only confirms SBP's weak effort and slackness to spur growth.

There are many worrisome factors in the financial sector that require immediate attention.

Piling up of government securities by banks, as the outstanding stock as of December 31, 2011 has surged to Rs 3.679 trillion that has clearly exceeded the banks' total lending of Rs 3.357 trillion, further confirms the real cause of fall in Pakistan's growth rate.

The break-up of investments in government papers is: T/bills Rs 2.515 trillion, PIBs Rs 881.9 billion and Sukuk Rs 282.3 billion.

Latest figures of investment in government security based on SBP data suggest that in the absence of cap allowing banks to invest any amount in government paper, investment in government paper has surged to an all-time high of 67.94 percent, as banking sector has been blessed with an opportunity to comfortably park its funds in government securities instead of lending money to new businesses.

This could have never been possible without central bank's assistance.

With so much of excess liquidity available and government struggling to increase growth rate and create new jobs due to growing population, which is increasing by 2 percent or 3.7 million annually, it is SBP's tight policy stance that should be blamed for causing stagflation, as it has choked all growth prospects.

Such issues should be given top priority by the political leadership and our politicians should discuss this serious matter in Parliament and with Governor State Bank of Pakistan in the presence of parliamentary finance committee.

SBP should choose the right direction, as it has no right to punish the growing population due to no fault of their's.

For how many more years will the economy/businesses suffer due to a high interest rate environment the central bank has maintained due to its inability to reduce government borrowing, ever-rising currency in circulation that has reached Rs 1.685 trillion, fiscal deficit that has been hovering around 6.5 percent.

Non-performing loans (NPLs) surged to an alarming high of 14 percent that has blocked rupee liquidity equivalent to Rs 650 billion caused by SBP's high discount rate policy and banking spread.

In a span of 5 years, due to an exorbitantly high interest rate environment, Pakistan's domestic debt is laden with additional burden averaging over 12 percent, which during this year, has increased by around Rs 2.6 trillion or USD 32 billion that is more than the foreign funding received by the country.

SBP has to choose between good (growth) and evil (inflation containment).

The real problem faced by economy is credit expansion that leads to growth, which is not happening due to continued high discount rate policy.

High discount rate encourages banks to put all their money in a government security that is less risky asset and offers hefty return.

Therefore, unless discount rate is chopped by another 4 percent to 5 percent, businesses will never flourish, private sector will never grow, jobs will never be created and stagflation would continue to haunt the nation.

SBP should no more act as banks' agent to sell government securities; it should shoulder its responsibility to boost growth rate by gradually reducing the discount rate and let the commercial banks decide if they want to increase their income through credit expansion.

Conventional wisdom says that any bank in the world would happily park all its funds in a central bank pool, which is the safest place to invest funds and especially if that bank is provided with an opportunity to earn a banking spread of 7.5 percent.

Such policies would certainly be unacceptable at any decent place.

Why do we have to cry and bang our heads blaming corruption and tax evasion for all the ills, when the regulator is itself a party to such practices as it prefers to articulate and implement a policy that only suits banks.

High banking spread is one of the major causes of sharp rise in currency in circulation and a decline in national savings ratio and promotion of dollarization.

With a low discount rate environment banks will be forced to look for new avenues, which would encourage lending to private sector that would ultimately give much-needed boost to economy.

Further, if banks do not offer depositor's market-based rates after a discount rate cut then depositors will surely shift their funds to government instruments, which should continue to be depositor-friendly.

Slashing discount rate by 5 percent will do a world of good for the country the annual cost of domestic debt financing that has risen to Rs 6.439 trillion because of a high discount rate.

It will be reduced by 41.6 percent, which is Rs 322 billion or USD 3.579 billion annual saving.

The lesson that we can learn from current global financial crisis is that economies depending on foreign money cannot survive on borrowing for ever and have to find domestic means to generate sufficient revenue and increase exports earnings.

India can be taken as the most recent example.

Despite having forex reserves of USD 303 billion, which is good enough to cover 9 months of imports, India has become a casualty due to global meltdown and is struggling to mend its economy.

The real cause of worry/financial unrest in India is because the foreign money has stopped flowing in.

It has forex reserves of $303 billion and currently holds USD 275 billion foreign money.

Out of which Non-Indian Resident (NRI) funds consist of USD 52 billion of which USD 43 billion matures in June this year, but does not carry significant risk as NRI can be considered safe money.

The biggest concern is that the remaining amount of USD 223 billion that matures by July 2012 carries a huge risk due to European crisis as India's total stock of portfolio investment is currently around $138 billion and short-term debt is $137 billion.

Suppose if a large part of funds gets matured and not rolled over, it could be extremely difficult to arrange these funds.

India's growth is already slowing down while its deficit is ballooning.

At present, India spends around USD 130 billion annually on oil purchases because it consumes 3.182 million barrels per day and with simmering Iran issue, higher oil price could be a disaster for India.

So India is standing barefooted on dynamite and its exchange rate may remain under pressure for some time.

Pakistan too is a deficit economy, so it should draw a valuable lesson from India and try to get rid of the Western methods; and it should decrease its foreign dependence, which is purely artificial means of fixing things.

Hence, instead of complaining of drop in FDI or no foreign Investment, State Bank of Pakistan should come up with some innovative ideas.

It should not delay using its monetary tools in a more effective manner to gather domestic growth momentum.

There is sufficient room in our unexplored domestic economy that can face the challenges.

Pakistan should more seriously focus on agriculture sector growth, as global food demand will not fall and it can become the biggest source of earnings.

What is required is that we need to spend more money through increased bank financing to modernise agriculture sector.

SBP is therefore required to activate the sector by offering fresh incentives.

Construction could be another major source of growth that can kick-start the stalled economy.

So nothing is lost, all that we need initially is a professional input from subject matter experts who know their job well.

Although we are not a party to the Western blunders, we are facing the consequences of our own wrongdoing as we failed to implement a long-term effective policy due to a lack of vision by our policymakers.

The problem is that our economic growth is largely based on hormones and such growth always has health concern.

We have to realise that this type of growth has a pretty short life, so we have to shift our stance and devise a strategy towards long-term growth.

We are still growing 23-24 million tons of wheat that was achieved about 10 years ago.

Our cotton growth is down by 2 million bales; 10 years ago we were growing over 14 million bales.

We are growing rice in abundance, which is easy to cultivate.

But rice export is losing its charm overseas due to each importing country's specific domestic need.

We do not have the will/vision to cater to the need as per importers' requirements; so rice export could fall.

Our food and vegetable exports remain very thin.

This area, therefore, does not heed much discussion.

Food and vegetables have good overseas market demand but we have never bothered to meet the international market standards required to meet import standards and most importantly, we can only export raw material and yet learn the finishing art.

Pakistan should learn from the recent change/shift of economic growth pattern from Western economies to Eastern economies, which is due to increased commodity production on substantial rise in global commodity prices.

JAN 02, OutLook 2012 - Euro 1.0462 – GBP 1.3550 – JPY 68.50 – CHF 1.0430

http://www.forexstreet.net/profiles/blogs/outlook-2012-euro-1-0462-gbp-1-3550-jpy-68-50-chf-1-0430

FX OutLook 2012 Euro 1.0462 – GBP 1.3550 – JPY 68.50 – CHF 1.0430

January 02, 2012

Managing of debt will remain the global priority. Growth, job creation, inflation, higher food prices, higher oil, higher energy etc are all secondary issues. This means that the world may be heading for another difficult year. It is evident from constant downside revision of global economy suggesting that recession will continue to be the dominating factor. It will not be surprising to see many economies heading into negative growth area. Europe will remain a key talking point in the first half of 2012, as European market is expected to remain fragile and risk of contagion is high.

Global focus in the 1^st 2 quarters of 2012 would be on Europe as it could be a difficult beginning since banks will have to meet the capital adequacy requirement, which poses difficulty to lend in the corporate sector meaning tighter credit condition.

Majority of the countries in the Euro zone region is facing fiscal tightening and will have to curtail spending to bring down the surging deficit number unacceptable to the policy makers. Higher funding cost is another factor that would hinder growth in the region.

But Europe could face a bigger problem of balance of payment as many countries are required to feed their import bill. The problem is that USA has stopped lending to European banks. There are reports of flight of capital from European countries, which is also bad news for the region.

Overall, outlook for 2012 looks very difficult because despite numerous announcements, meetings and commitments, the outcome is not convincing or very impressive, which creates doubt in mind, though European Central Bank injected roughly Euro 500 billion in December 2011, but market is unsure about the next direction because banks did not give loans to business to boost economy. Neither had they offered funds to banks that offered profitable return due to mistrust. Some of the estimates suggest that in 2012, Europe requires USD two-trillion to meet the funding demand. The credibility factor of EU remains unresolved issue. Therefore, Euro zone break-up is still a huge possibility.

The other influencing factor that could impact Euro zone economies in 2012 is the rating cut, which may be a common news flash during the year. Europe cannot escape from further rate cut and quantitative easing and elections in Europe will provide more clues about the mood of people.

However, I expect Euro zone to remain intact. Despite opposition Euro will go for more quantitative easing, which is the only option available.  Monetary union will not break up, but we will surely see some countries partying away. There is a huge risk that any unfavorable event could lead to protectionism and hence European currency will come under severe pressure. 

Unlike Europe, sentiment for the US economy is in mildly bullish mode for the short term period. Recent US economic data have further helped in setting the tone. USA is already done with the big event of downgrading. US banks have tightened its noose on European bank and are refraining from lending, which gives further strength to its banking system. But despite cold shoulder shown by the Chinese, investment in US Treasuries remains very attractive, which performed better than corporate bonds and was the best performing asset class of 2011, which means demand for US treasuries this year would remain high.

The other positive for US economy and US Dollar in comparison with Europe is that USA is expected to grow slightly above 2 pct versus zero pct growth expected in Europe. So if USA is performing well, US investors will invest in USA, which is good enough for stimulation for US economy.

I think to avoid interruption US will continue with its monetary easing policy to keep up the pace of growth and USA will go for 3^rd monetary easing to boost its housing sector, which could improve the job market condition.

However, we should keep focusing on European sovereign debt problem that could have contagion effect, as it may easily spillover into US economy as well. Europe’s goods and services to USA accounts for over USD 400 billion. US Bank’s exposure to German and French banks is roughly USD 1.2 trillion and to PIIGS country is around USD 640 billion. So worsening of European problem could easily drag USA as well.


EURO @ 1.2950 will remain under severe pressure during 1^st quarter. Technically the currency will find 1^st support around 1.2238 areas with crucial support at 1.1866. I will not surprised to see a bounce from hear, but may find resistance around 1.25 zones and requires monthly close above this level, failing to penetrate beyond means another dip and break of 1.1866 for 1.0895 or possibly 1.0462.However, on the upside break above 1.3620 would suggest Euro could be heading for more gains and may test another important resistance level of 1.3980. Break here confirms more bullish move towards 1.4550.
I am bearish for Euro and looking for substantial fall. But Sarkozy election will play key role in currency moves, because if he wins he may not be willing give up Euro neither would German leader be willing support French leaders thought. Sarkozy’s exit could mean Germany’s domination which may provide support to Euro.


GBP @ 1.5510 despite tough economic condition and plenty of problems like high inflation, deficit and job losses piling up in UK as there is a growing risk of negative growth for the second consecutive negative growth, which means another recession in next quarter. BOE will go for another round of quantitative easing, but British economy is likely to do well in 2^nd half.
Pound Sterling may occasionally enjoy against Euro in crosses, but the British currency’s level on break 1.5230 to watch is 1.4950, but requires a clear break for a test of 1.4373 or possibly Cable will be dragged down to  1.3550 due to European financial crisis because Europe is UK’s largest trade partner. However, on the upside break of 1.6355 could be threatening for a test of 1.7565.


JPY @ 76.90 I believe that Yen will continue to blossom despite economic difficulties, lowest return in bond yield and threat of BOJ intervention. I am looking for convincing break of 74.80 this year for a move to 73.85. Real test could come around 70 Yen per UD Dollar, only break would pave way for 68.50. However, suggest watching 79.90 a break would encourage for a test of 82.75 that could brighten chances of a test of 84.50


CHF @ 93.90 is the currency to watch, as investors will keenly follow this currency during Euro meltdown, if that happens. In crosses SNB may have to frequently step in, as market could retest EUR/CHF 1.20 levels.  I am expecting a break of 0.9580 for 0.9943. A clean break and monthly close of this level would pave way for 1.0430. However, if 0.9020 breaks 0.8776 would be important level to watch, which could mean test of 0.80.