KARACHI: The rupee plunged by 3.1 per cent in the opening hours of interbank trade on Wednesday, sparking a shortage of foreign currency in the open market as dealers preferred to hold rather than sell.

By midday the dollar had risen to Rs108.50 before settling at Rs108.25 by close. This is the largest single drop in the currency in nine years, according to Bloomberg, and there is no clarity on how far it might go in the days ahead.

The State Bank of Pakistan (SBP) held its silence during the day as the slide continued unabated, creating serious concern amongst bankers as rumours swirled that the move might be engineered to advance political goals. But hours after the close of trade, the central bank issued a statement owning the move, saying it had become necessary due to a growing deficit in the external account.

“The exchange rate adjusted in the market and the SBP is of the view that this depreciation in the exchange rate will address the emerging imbalance in the external account and strengthen the growth prospects of the country,” said the SBP, adding that it also believes “the current exchange rate is broadly aligned with the economic fundamentals.”

Meanwhile, the move drew a sharp reaction from the finance ministry where an emergency meeting was called in the afternoon. A strongly worded statement issued after that meeting called the decline “artificial” and said it had “negatively affected our foreign exchange markets”.

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The finance minister “expressed deep concern, indignation and disappointment” at the move, before adding that “the current political situation is being exploited by certain individuals, banks and entities”. The statement threatened “appropriate action” against those responsible, “in the national interest”.

Presidents of domestic banks have been summoned to Islamabad for an emergency meeting at the finance ministry on Thursday morning. If the finance minister insists on ordering action to restore the rupee back to its original value before Wednesday’s declines, it could set the stage for a clash as banks find themselves caught between the regulator and the government. Legally the finance minister has no powers to compel compliance since those powers are with the State Bank, but informally he wields a great deal of clout.

This is the first open rift between the SBP and finance minister who has been dominating the bank’s affairs for the last four years. The central bank is currently headed by Riaz Riazuddin as an acting governor, who is a career SBP staffer. His term runs till July 28.

The drama started in the morning as the rupee lost against the greenback but the usual interventions from the State Bank did not come, a senior banker told Dawn. “Normally they call with instructions, but when no calls came, we asked them and were told that they are under instructions to let the rupee go.” At that point in time it was unclear where the instructions had come from.

A source in the State Bank told Dawn that the decision is actually months in the making. “This was a decision made at the State Bank, nowhere else,” he said.

“The banks were conveyed a message from the central bank that they should cover the entire imports which means the SBP would not support the banks any more,” said Atif Ahmed, a currency dealer in the inter-bank market.

The State Bank usually supports banks to cover imports and helps to stabilise the exchange rate regime.“We believe this was long overdue as the Pak rupee has been relatively stable since August 2015. Further, during the last 10 years, the rupee has devalued annually by 5 per cent,” said a note of Topline Securities.

“A one-off devaluation move does little to ease pressure on the deteriorating balance of payments position. Rupee is still significantly overvalued than its fair value,” said Eman Zubair from Tresmark.

Published in Dawn, July 6th, 2017