Regional factor in exchange rate
With growing competition in export markets, the exchange rate management has assumed a special significance in South Asian states, competing fiercely not only in global markets but also trying to boost intra-regional exports.
India and Bangladesh are Pakistan’s two main competitors in several export products including textiles and food whose combined foreign exchange earnings make up around 70 per cent of its total exports.
That is why the State Bank of Pakistan keeps an eye over Indian rupee and Bangladeshi taka and tries to respond to market requirements emerging out of any noticeable development in regional foreign exchange market.
“But it’s not always a dominating factor in the timing or the nature of the SBP moves to help our local forex market,” insisted a senior central banker. “The more dominating factor remains our own outlook of exchange rates and the feasibility of available options to influence forex market.”
In 2012 rupee lost eight per cent of its value against the dollar (falling from 89.95 a dollar by the end of 2011 to 97.15 a dollar by the end of 2012) mainly due to weakening of external sector. And the magnitude of the currency depreciation was perfectly in line with the amount of pressure on external inflows of foreign exchange.
Central bankers insist that the depreciation was mostly market-driven with the only exception of a few speculative attacks on the rupee that were successfully checked through regulatory measures or moral suasion. But bankers say that signs of regional competition in exchange rate management also became visible at times—not in terms of the magnitude but in the timing of the changes in exchange rates.
For example, Pakistani rupee lost just 0.8 per cent value against the dollar in the first quarter of 2012. That was the time when the Indian rupee had gained 3.7 per cent versus the dollar (moving up to 50.02 a dollar by end-March 2012 from 52.91 by end of December 2011).
In the second quarter of the last year the local currency shed 4.3 per cent value against the dollar as trade deficit continued to expand due to falling exports and rising imports and drying up of foreign direct investment inflows.
During this period Indian rupee recorded the biggest ever quarterly decline of 11.2 per cent (coming down to 55.63 per dollar by end-June from 50.02 by end of March 2012) as Indian exports too suffered setbacks
“My point is simple. After a relative stability in the first quarter (when our rupee fell just 0.8 per cent) there was enough room for the central bank to let the rupee find its real market value (amid lower supplies and higher demand). But the freefall of the Indian rupee provided an additional justification,” said treasurer of one of the largest six commercial banks. “Our exporters
would have landed in trouble if the central bank had tried to block by any means the decline in our rupee value at that time.”
Back in 2011 when Bangladeshi taka had lost 10.4 per cent value against the dollar in the second half of the year (coming down from 74.14 per dollar at end-June to 81.83 per dollar by the end of December), Pakistani rupee had also shed 4.7 per cent against the greenback during the same period.
These periodical movements in exchange rates are among many examples that foreign exchange dealers quote to make a point:
that regional exchange rate considerations often become part of the policy background of the central bank before it makes any move to influence demand for dollars in the market at a particular time. This is, however, not to suggest that other considerations like actual demand and supply position of foreign exchange play a lesser role in determining the volume and velocity of change in exchange rates.
“When the market is short of foreign exchange, the central bank sometimes sells dollars in the interbank market on spot or through dollar-rupee swaps. But SBP tries not to remain a net seller at the end of every quarter or at best at the end of every fiscal year. Quite often the timing of the decision to let the rupee fall on higher demand for dollars coincides with depreciation in regional currencies” explained chief foreign exchange dealer at a reputed local bank.
Growing pressure on foreign exchange reserves for the last two fiscal years has, even otherwise, made it difficult for SBP to make
frequent injections of foreign exchange in interbank market. “And now it does so only on occasions when the rupee slide seems to be originating from speculations rather than real interplay of demand and supply forces,” said chief forex dealer at another bank. Exchange rate management has thus become more challenging for SBP. Treasurers of local and foreign banks say that keeping the rupee value from falling too rapidly calls for perfectly-timed actions of the central bank and enhanced discipline of foreign exchange market.
“If you analyse monthly or quarterly changes in the rupee-dollar exchange rates you’ll notice that whereas regional trend does reflect either within the same quarter or in the next quarter. But month-on-month changes are dictated more by actual demand, supply situation plus forward dollar buying by SBP ahead of the quarter-end external debt payments,” said an official of state-run National Bank of Pakistan.
That is perhaps why the rupee had lost more value in the second half of November and first two weeks of December last year because that was precisely when SBP was readying itself for making year-end external debt payments.
As a result, when the time came for actual outflows there was no unusual rush on the dollars. Between mid-November and mid-December 2012 the rupee shed about 2.4 per cent value against the dollar, coming down from 95.86 a dollar on November 15 to 98.14 a dollar on December 17. But in the next two weeks the local currency rather recovered swiftly rising to 97.15 per dollar by the end of December.
Apart from consideration about export market competitiveness and in addition to concerns about external debt payments amid not-so-healthy external sector, another important factor that now features prominently in exchange rate management is the impact of exchange rate changes on imports bill.
Senior bankers say that analysis of quarterly movements in exchange rates of the last two years provides some clues on understanding the link between exchange rate changes and change in imports bill. Imports bill were growing till the first half of 2012 but we see signs of deceleration in the second half when exports actually picked up after remaining on the decline in the first half.
“On the one hand, it was the rupee depreciation that made imports costlier thereby checking their growth rates but more importantly our imports growth was also contained by another factor,” argued a trade finance official of Askari Bank.
“Diversification of export items over time has lowered our spending on imported raw materials. Compare the imported raw materials of textiles or leather industry, for example, with the import requirements of jewellery, cement and value-added food items and you’ll see that these items rely and spend much lesser on imported raw materials or components.”