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Higher interest rates and tighter liquidity will help curb buying

Oct 09 - 15, 2000

The panic booking by the importers, holdback attitude of the exporters speculating a better return, mopping-up by the government for debt servicing and speculative buying are the major factors creating an unusual demand for the dollar both in the inter-bank as well as in the kerb market.

The rupee, as a consequence, came under immediate pressure, with recent debt payments leading to a sharp decline in its value against the dollar. The rupee fell as low as Rs59.80 on October 4, which was a 12.5 per cent appreciation of the dollar. The central bank has been supporting the rupee through direct intervention selling a reported $60-70 million in the inter-bank foreign exchange market.

Syed Sajjad Haider of Finex Securities while spelling out the factors mounting pressures on rupee-dollar parity felt that the price of Rs52.10-Rs52.30 fixed for official trading was not the genuine one. On July 20 when the central bank placed the rupee on a free float withdrawing the unofficial trading band, the entire backlog held up for such a long time found a way in the form of battering the rupee against the dollar.

The recent financial measures taken by the SBP and more in the offing may help rupee to regain stability in the days to come. Otherwise the rupee could slide down even to the extent of Rs70-75 if the market forces were not bridled.

On October 4, the SBP raised its discount rate by 100 basis points to 3 per cent and also increased the cash reserve requirement (CRR) for banks to 7 per cent from the earlier 5 per cent. The move is seen as an attempt to drain liquidity from the banking system to curb speculation in the inter-bank foreign exchange market due to the recent pressure on the rupee on account of large debt payments. The SBP also raised cutoff rates in the latest Treasury bill auction. The 3-month t-bills cutoff was 10.50 per (up 199 basis points over previous auction); 6-month t-bills cutoff was 11 per cent (up 200 basis points) while 1-year t-bills were issued at a cutoff of 11.50 per cent (up 222 basis points)

The gradual increase in interest rates was another step to stabilize the rupee. Intervention however has so far failed to stop the downward slide of the rupee. In addition, the last hike in discount rate (19 September) and a sharp increase in cutoff rates also did not have the desired effect. October 4 decision to further increase the discount rate and cutoff yields together with the increase in CRR signals the SBP's continued use of tighter monetary policy to support the rapidly declining rupee. It is expected that higher interest rates and tighter liquidity will curb speculative dollar purchases in the inter-bank market. It is also hoped that the emerging scenario might compel banks to offload their excess noster dollar holdings into the market.

The financial experts however feel that the latest interest rate hike bears well for banks, however its negative implications for both the economy and the equity market should also be kept in mind. The low interest rate environment of the past two years had only recently begun to bear fruit in terms of its impact on investment and domestic demand. The corporate sector had started to actively refinance its more expensive debts thereby reducing financial costs and increasing appetite for further credit. Higher interest rates also have a negative impact on stock valuations as these are linked to investors' required rate of return or the discount rate used to value the cash stream offered by financial instruments.

The decision taken by the commercial banks to self impose 30 per cent cash margin on all imports and the measures for financial restructuring taken by the central bank are expected to clip the dollar wings. The SBP on its parts is reportedly considering capping inter-bank foreign exchange rates once again to stabilize the rupee. The Central bank may however be required a green signal from the IMF before going for re-imposing a trading band. The market forces however feel that need for putting a cap on exchange rate may not be arise in view of the tight financial measures already taken by the State Bank of Pakistan.

It may be mentioned here that the removal of a cap on exchange rate since July 20 resulted in a 13 per cent devaluation against the dollar so far.

Meanwhile the foreign exchange dealers and State Bank of Pakistan (SBP) have reached an understanding to bring dollar further down to Rs58 in inter bank and Rs60 in the kerb market.

The government had allowed floating dollar to level of only Rs58 as was agreed with International Monetary Fund (IMF), however greenback crossed Rs60.

The Forex Association of Pakistan (FAP) has urged the SBP to cancel the swap fund facility which was allegedly being misused by the importers and requested to approve the demand. Swap had facilitated speculations and now they are off the scene.