Home / This Week / Cover Stories / EXCHANGE RATE GOVERNANCE AND MAINTENANCE UNDER SBP: Flexible exchange rate will help achieve sustainable macroeconomic goals

EXCHANGE RATE GOVERNANCE AND MAINTENANCE UNDER SBP: Flexible exchange rate will help achieve sustainable macroeconomic goals

The banks account for 80 percent of international remittances coming through formal channels into Pakistan, given their long history in the sector. The formation of exchange companies (ECs) in 2002 has significantly increased flows as hundreds of small moneychangers have been brought into the regulated sector and now account for more than 17 percent of international formal remittances. Both banks and ECs have multiple correspondents and relationships abroad. After 9/11, State Bank of Pakistan (SBP) took further action to formalize remittances, such as setting up centralized home remittance cells and forming exchange companies in 2002. The formation of exchange companies has significantly increased the flow of formal remittances with hundreds of small moneychangers being brought into the regulated sector.

The Exchange Company framework was enforced in 2002 to bring exchange and remittance businesses under proper financial discipline. With the transformation of authorized moneychangers into formal ECs, a large number of undocumented and cash international transactions came within the formal net. These transactions are required to have proper documentation, record keeping, and adherence to internationally accepted ‘Know Your Customer’ norms. All Exchange Company transactions, exclusively international money transfers, are fully automated and have a real-time online network that can be accessed by any branch to track and make payments. Many ECs have set up call centers where the franchisees can call and check a transaction status.

The EC framework also enabled SBP to substantially narrow the gap between interbank and curb market exchange rates, which has played an important role in improving the inflow of international remittances during the past two to three years. The transformation of authorized moneychangers into formal ECs, however, has posed considerable challenges for SBP in ensuring effective regulatory and supervisory oversight, inculcating corporate culture, good governance, transparency, and proper documentation and record keeping structure.The network of ECs is comprehensive, covering 100 percent of the urban market and slowly making inroads into rural areas. According to ECs, 90 percent of remittance transactions they handle are between Rs10,000 and Rs100,000.

In Pakistan’s case, workers’ remittances are an important source of foreign exchange earnings and finance a large portion of trade and services deficits in the current account balance. Workers’ remittances turn out to be significant and have a positive sign, which reflects the increase in the remittance inflows cause appreciation of the real exchange rate.

The official intervention of monetary authorities in the foreign exchange market to influence the exchange rate fluctuation is a worldwide phenomenon. The monetary authorities intervene with the objective of maintaining orderly market conditions, which ultimately help to achieve the overall macroeconomic goals. Heavy intervention was witnessed in the beginning of 1973 by developed economies to smoothly shift from the Bretton Woods fixed exchange rate system to free float. However, Pakistan, like many of the other developing economies, continued with the fixed exchange rate regime until 1982 when it shifted to manage float. In July 2000, Pakistan shifted to free float, which in turn led the PKR/US dollar parity to depict a great deal of volatility. The management of foreign exchange market was indeed not an easy task; especially, when the foreign exchange market was thin and dominated by a relatively small number of agents.

The State Bank of Pakistan (SBP) started intervening in the foreign exchange market to moderate the exchange rate fluctuations by both managing the mismatch between US dollar demand and supply and by suppressing the speculative moves of a few agents.

Since the free float of the Pak rupee, monetary policy has played a dominant role in stabilizing the exchange rate in Pakistan. Significant ups and down in forex rates are now being monitored through effective instruments of monetary policy. Similarly, whenever speculative activities are observed in the market, they are tackled with proactive monetary policy measures of the Central Bank. The Bank uses the instrument of the discount rate to control undue pressure on the exchange rate while Cash Reserve Requirements (CRR) or mopping up of excessive liquidity through purchases from the kerb market, to curb speculative activities in the forex market.

In order to achieve sustainable macroeconomic equilibrium, monetary and fiscal policies must be consistent with the chosen nominal exchange rate regime. Further, the misalignments in the real exchange rate can be used as a guideline for policy interventions by the SBP. Policy measures should be identified and if needed, should be introduced immediately to correct any actual or even potential misalignments of the exchange rate. The exchange rate should be flexible to maintain a competitive position in the world market.

The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

Check Also

The future of Gwadar

The future of Gwadar

In December, 2020, the 5th meeting of the Joint Working Group on Gwadar, which includes, …

Leave a Reply