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.