Rupee volatility

The currency has been getting weaker despite the best efforts by the central bank

July 05 - 11,1999

The weak fundamentals for the Rupee has been stressed in the past. There are growing concerns despite the best efforts by the central bank to control exchange rate volatility. Recently, in order to check rapid fluctuations in the interbank market, the central bank disallowed banks from trading in foreign exchange unless they have a proof of customer's genuine requirement. Also, banks have not been allowed to book foreign exchange contracts of less than one month tenure. This was termed not a new move in itself. The banks will be required to square position of less than one month at the spot rate, rather than the practice of using the forward rate in the past.

The decision to refrain banks from taking any position, at all, in foreign exchange without any proof of customer's requirement is a clear step to try and prevent any little speculating power that the banks enjoyed previously. This move was followed by suggestions that banks had been advised to discourage trading in greenback above a certain band-width.

This shows that the Rupee is set to further weaken shortly. Recent trend in conversion rates is interesting. It is surprising that there was stability in interbank rates at a time the kerb rates were moving higher. This did not appear logical keeping the trend of foreign trade figures in view — indicating a growing deficit.

The gap between interbank and kerb rates has been widening since April. According to some analysts, such a wide gap virtually creeps into the official exchange rate as well in the form of an artificial hike in imports and a corresponding drop in inflows. They also do not expect any improvement in the situation in near future. Therefore, they say that there are clear signals of currency weakness. However, given the magnitude of the gap between the interbank and kerb rates at present, it may be a little before the exchange rates correct. But there seems to be trouble ahead.

Analysts believe that Rupee is getting weaker day by day and the central bank will not be able to contain the rate artificially. They say that administrative measures can help only for a brief time. The ultimate exchange rate has to be fixed through market mechanism. They say that exchange rate is the only deterring factor in volume of trade be it official or smuggling. Once the parity becomes too high not only official imports come down but smuggling volume also reduces, simply because the demand goes down.

However, the people who keep only short-term perspective in mind, say that the expected release of the IMF tranche will be enough to meet the short-term requirements. But, there is no plan to meet the enhanced debt servicing requirement for period after year 2000. They say that the release of IMF tranche secures maximum 2 to 3 weeks position but one has to take into account at least 6 to 9 weeks outlook.

Their views consolidate the belief of the group which says: "Expectations are more important than the actual happenings." The widening gap between interbank and kerb rates provide a strong cue that the Rupee is getting weaker with the passage of time. Imports are on the increase and exports are on the decline. But why does this happen?

Fearing further erosion in exchange rate, importers open letters of credit for higher quantities and exporters request for delays in getting the remittance. Along with this, another phenomena is in working. Banks are discouraging opening of new foreign currency accounts. The rate of return on these accounts offered by the banks are ridiculously low.

State Bank of Pakistan (SBP) has reduced the rate of return on foreign currency deposits which are deposited with the central bank. Earlier, SBP had prohibited banks from placing any forex deposits abroad and any foreign currency deposit that cannot be placed in the interbank market has to be surrendered to the central bank. This move will act as a further disincentive to banks to accept foreign currency deposits as their return on these deposits will be even lower than the present LIBOR which is being quoted around eight per cent.

However, some analysts say, whatever may by the rate of return, people interested in accumulating dollars will keep their savings in foreign currency.


The IMF has reportedly announced the release of US$ 300 million tranche under ESAF/EFF facility. The review mission is expected to visit shortly to conduct its periodic survey on economic performance before the release of tranche. Most of the conditions of the next tranche had already been discussed and agreed upon in June when the IMF review mission visited Pakistan. The Mission expressed that Pakistan's performance on the capital market reforms was lacking. The government has assured the Fund that there would be work on this front. Regarding privatization, the IMF has already reached an understanding with the government that the global environment is not conducive for divestment.