Rupee trades under severe pressure during January 2010

Wednesday, 03 February 2010 15:37

Highlights - Business News

Included in this report:

General overview:

The US dollar showed an upward movement through January 2010 and touched record highs in the open as well in the interbank market. Dollar touched a new level every new day and the same trend continued to prevail during the whole month. Rupee fell to record lows and for the first time in the history of currency trading, US dollar touched and even traded above Rs. 86/- mark in the open market. The difference between inter bank and open market rates also widened during the month under review. There was no respite for the national currency which started and ended the month under severe pressure.

Month Rates Chart:

Dollar started new year at a strong note as the exchange price on January 02, 2010 was Rs. 84/25 for buying & Rs. 84/40 for selling which later went up to Rs. 86/20 & Rs. 86/50 for buying & selling respectively. Hence rupee got cheaper by Rs.1/95 paisa against the dollar with no major recovery during the entire month.

Factors behind rupees fall:

There is a constant pressure on Pak rupee since few weeks mainly because of persistently increasing demand pressure in the inter bank as well as in the open market. Let us review these factors individually for a better understanding:

Interbank: In the inter bank, there has been an anticipated pressure on national currency.

IMF Conditionality:

This depreciation was anticipated in the sense that the central bank had stopped providing dollars to the oil companies under International Monetary Fund’s lending framework to correct macroeconomic imbalances. Pakistan had signed an agreement with the IMF in November 2008 that bounded the State Bank to pursue a flexible exchange rate policy. Under the IMF conditions, intervention in the foreign exchange market by the SBP (including the provision of foreign exchange for oil imports) will be aimed at meeting the given reserves target.

The IMF programme had set February 1, 2010 as the last date for the SBP to shift the entire oil import bill payment to the interbank market.

Oil Payments through Interbank:

After the IMF agreement, State Bank of Pakistan had shifted all the crude oil related payments towards the banking sector of the country in accordance with the International Monetary Fund (IMF) from December 14. It was decided that all purchases of foreign exchange related to import of crude oil shall also be made by the banks (ADs) from the Interbank Market. Earlier in February 2009, the central bank had shifted high speed diesel import payments to Interbank Market, while on July 15; it shifted its POL import burden to the banks as well.

The banking channel of the country is now paying about 100 percent of the entire oil import bill which stands above US $5 billion. Earlier, the central bank was using its foreign exchange reserves for importing crude. The lending framework now bars the central bank from using its foreign exchange reserves to make import payments.

The oil companies/refineries hence are now borrowing from the inter bank for their oil imports. The banks are rushing in to arrange foreign currency for importers of petroleum products and crude oil. Further, the quarterly payment requirement from the corporate customers is adding more demand pressure and hence, this huge demand is causing a free fall of rupee.

Open Market: Since the dollar is strong in the interbank, it is keeping rupee under pressure in the open market too. This is due to the basic phenomenon that whenever there is an increase in the price of dollar in the interbank, its technical pressure is seen in the open market dealings as well. However besides this lone fact, rupee kept on losing its shine against dollar not only on fundamental & technical grounds but also due to speculative trade.

Speculative trade:

Some elements remained very active to take advantage by taking short positions made gains out of this volatile market. Such buyers popularly called speculators kept on demanding dollars in huge volumes whereas funds transfers also showed an increasing trend. According to market sources, the average demand of greenback has gone up to US $ 4-5 million daily as compared to US $ 2-3 million earlier. Rapidly changing scenario after NRO judgment of Supreme Court of Pakistan and already dismal economic performance for quite sometime now especially due to security and law & order situation of the country; an increase in funds transfers is being recorded.

Dollars smuggling:

Besides the activities of the speculators, dollar purchase also went on a rise for smuggling to Afghanistan. President Forex Association of Pakistan Malik Bostan confirmed these reports while talking to various media sources. He confirmed that the smuggling of dollars to Afghanistan had increased these days which had created shortage and have pushed the prices up. He further said that the banks were charging 75 paisa per dollar on transactions made by the overseas Pakistanis; however, ‘Hundi’ and ‘Hawala’ dealings are benefited by this act. This is also a reason behind decline in dollar’s supply.

Hundi & Hawala:

The difference between open and inter bank dollar rate also widened during the month under review which is creating an obvious room for illegal transactions of the currency. Usually the hundi and hawala operators find such market situation attractive as the customers try to get advantage of a higher rate of dollar on their remittances. Hence they also came into the market and created an abnormal pressure on the national currency.

Central Bank’s moves during January 2010:

Statement regarding current state of rupee:

The central bank issued a statement during this month to clarify its position on the current free fall of rupee against dollar. The statement said, “It is flourishing for rupee to see gain or loss in forex market trading as compared to other currencies. This gain or loss in rupee value in forex market gains ability in rupee to sustain any sudden extra-ordinary ups and downs in its value.” The statement further said that “Current rate of rupee value in forex market trading does not reflect any formidable situation or any extra pressure.”

Our Analysis of the statement:

Such statement from the central bank reflects its two fold strategy. Firstly it highlights that SBP’s strategy to allow depreciation of rupee being followed under IMF terms and conditions. We had also stated this fact in our earlier reports that after IMF arrangement in Nov. 2008, SBP was supposed to transfer the entire oil payments burden to the inter bank instead of financing it through its reserves which will ultimately result in depreciation of rupee. By declaring that the current market situation does not reflect any extra pressure; the SBP has made it very clear that the current level of rupee against the US dollar is ‘acceptable’. This implies that there would be no intervention from the SBP in the near term as it was expected earlier. There was a popular perception in the market that the State Bank would intervene to stabilize the market but after this statement, this perception lost its grounds.
Secondly the current statement gives a clear cut direction that more depreciation may be allowed and hence the current market situation would prevail at least in the short term.

The tone used in this statement is of significant value and seems an effort to cool down the market under the present circumstances.

No action against dollar smuggling & huge funds transfers initially:

It was interesting to note that SBP initially didn’t address the issue of dollar smuggling & illegal activities of hundi & hawala operators which was reportedly one of the major reasons of rupee’s rapid depreciation. There were no solid steps from SBP to combat this situation despite of the fact that the central bank had taken serious action against leading exchange companies in Nov. 2008 when dollar had crossed Rs. 85/- mark. But at this point of time when even the President Forex Association of Pakistan Mr. Malik Bostan had openly told the media about the issue of dollar smuggling and that the hundi & hawala operators are taking full advantage of the current situation, the State Bank took its own time in taking any action for unknown reasons. Had it been only the genuine pressure in the market, this stance of the central bank would have been clearly understood not otherwise. Despite of unusual market movements, State Bank’s acceptance of the same surprised many analysts.

State Bank finally coming for the rescue:

FIA and SBP finally started a crack down against illegal money transfer operators and arrested a few individuals in Lahore in the last week of the month under review. This crackdown is expected to continue and has been initiated to control the record depreciation of the national currency. However there was no news of any further arrests and we just hope that this crack down will be conducted in true spirit for eliminating the illegal forces active in market these days.

Short term outlook:

Rupee’s performance during February depends on two factors. Firstly, if the crackdown against illegal money operators is continued in true spirit, it would certainly bring a positive impact on the current state of rupee. At least the speculative & unnecessary buying from the market would be eliminated & we may see some recovery/steadiness in the price of rupee against the US Dollar. Secondly since dollar’s genuine demand as well as the exchange price is strong in the open as well as the interbank markets; this decrease in unusual demand through crackdown would likely offset its impact on the exchange rate and hence we may not expect any major recovery in the price of rupee in the first two weeks of February. Keeping ahead the huge volume of demand, it would be unrealistic to say that increase in supply would bring a big change in the exchange rate specially keeping in mind that the supply side has been already weak off late.However we expect to see some recovery in the second half of February mainly because of the following two reasons:

Hence rupee would likely trade under pressure but may see some relief in the short term.