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How To Decide Fair Value Exchange Rate?

July 17, 2017

Asad Rizvi

There has been a great deal of discussion/debate over the past week about the fair value of Pak Rupee after sharp deterioration of Pak Rupee/Dollar exchange rate in the inter-banks market on July 5 2017.

It all started in the early hours of Wednesday morning after a large local bank kept on purchasing US Dollars in sizable lots by our standard from the inter-bank market, which saw break of crucial level 104-90-00.

In the absence of SBP, which is a normal ongoing market practice for years, I/B market got panic, as sellers were hoping that Central Bank would step in as per daily practice. But matters worsened as hopes of SBP intervention faded, prices got wide, as sellers of USD rushed to cover their short positions.

While, the inquiry is going on I don’t want to jump into a conclusion. But on the question that who made money ? Obviously early buyers and those opted for cheap Long Dollars were the real beneficiaries as Rupee closed at 108.25.

Following day was another interesting day as banks that were holding long US Dollar position against Pak Rupee had to book loss, as Rupee recouped its earlier loss after FM Dar decided to step in support of stable Rupee.

It is still mind boggling that when we have Semi-Float exchange rate system then why SBP’s External Relations Department had to come up with a Circular explaining that 3.1 pct exchange rate adjustment will address the emerging imbalance in the external account and strengthens the growth prospects.

Unless Exchange Rate structure is pegged, in a Semi- Float Exchange Rate mechanism Central Banks/ Governments do not have to notify fall in the value of currency. It is always the market force that through supply and demand factor determines the exchange rate direction.

Therefore, in my view, FM Dar did nothing wrong when he decided to intervene, as he is the Chairman of Monetary and Fiscal Policies Co-ordination Board and therefore he had acted under the law, as per SBP act 9 B (6).

Over the years, Exporters, Economist, Researchers and IMF are persistently demanding sharp depreciation of Rupee based on Real Effective Exchange Rate (REER) mechanism.

Recent history suggests that constant targeting of economy through REER is no more a contributing factor, as it is a failed economic approach.

There is clear evidence as data of last 10-years clearly suggest that despite 72 pct depreciation of Rupee, Pakistan’s exports failed to respond. Then the question arises that who are the real beneficiaries of weak Rupee. Of course if Rupee depreciates, Exporters will pocket excess Rupee against its foreign exchange receivables.

Economist/Research analyst are paid and forced to talk of a favorable market condition or else they will be loitering on the streets because in a declining or Bearish market they become useless.

While, IMF has a task to keep countries constantly engaged all the time through its tough conditional lending for longer duration, as interest earning through IMF lending is their major source of income.

Therefore, critics should not only refer to REER mechanism, instead they should come up with a explanation and proposition by addressing that how much is REER mechanism appropriate and effective to deliver in a Pakistani environment because in Pakistan it has completely failed to deliver in the last decade.

Central Bank Autonomy

Approach towards regulatory autonomy requires balanced point of view. It is true that that banking supervision and financial regulations require significant degree of operational independence.

Unfortunately Globally, Central Bank’s autonomy frequently comes under question due to inconsistent fiscal policy/support. There are many such examples, market witnessed oil averaging above $ 111 per barrel and Gold hitting all time high of $ 1917 per ounce in 2011. Inflation in 2012 in Europe and USA was around 2 pct, but interestingly ECB and FED opted for quantitative easing and zero interest rate policy, which was at the cost of Depositor’s Money that has inflated their bank balance sheet size to almost double to around USD 4.5 Trillion.

Funds were never given to corporate sector to stimulate economy. Sole purpose of liquidity injection to financial sector was to avoid banking sector collapse.

It is a known fact that governments all over the globe intervenes in Central Bank’s monetary affairs at various intervals to protect their National interest. Japanese MOF frequently intervenes in BOJ proceedings. South African Reserve Bank, People’s Bank of China, South Korean Central Banks and South American Central Banks too are known for active interference.

India is the most recent case as its Joint Secretary was sent to coordinate with Reserve Bank of India in its cash operations violating RBI’s management of its currency system.

It is a never ending debate, as governments all over the world would continue to interfere in country’s monetary affairs as and when required. Though Central Banks can play active role by applying its monetary tool to acquire Technical independence, but operation independence will never be easy to achieve because of frequent outside interference.

Understanding Exchange Rate Regime

It is widely acknowledged that in longer run monetary policy alone cannot contribute towards economic growth and job creation.

It is also an accepted fact that no single exchange rate regime is considered the best or most successful exchange rate mechanism. Therefore, a country should decide to adopt the exchange rate regime that suits best for its requirement.

Options offered by the Exchange Rate Regime are either Floating or Pegged. SBP opted for Semi-Floating Rate Mechanism.

While, for Pakistan REER has proved to be the back-breaker causing lot of pain and agony to economy with no gain in real sense. Over the years, Depreciation of Rupee has caused economic disaster instead of gains, pushing domestic prices of all food items to an extraordinary high level. It has caused sharp hike in Petrol, Gas and Electricity prices. Transportation prices have more than doubled. Hike had negatively impacted Rental, Education and Social Sectors.

Weak Rupee has pushed interest rate higher that had pushed cost of doing business higher and hurting exports. Spending money has become difficult in a tight liquidity environment that kicks budget deficit higher. Deficit financing has become very costlier. Ultimately any spending severely hits the debt side pushing it to new all time highs.

Meanwhile, SBP that opted for Inflation Targeting Monetary Policy Framework should stick to its explicit inflation target and should implement policy accordingly to achieve its target. But it is required to bring more transparency by adjusting its Target Rate in line with CPI Inflation.

It is noted that after cautioning the market since last 5-6 quarters, SBP has been incorrectly forecasting very high CPI number probably anticipating sharp rise in oil prices that may push inflation sharply higher that has not happened. SBP should realize the price government and economy is paying due to higher Policy Rates, which is very disturbing in the absence of Revenue shortfall and sliding exports. Therefore, it is expected that in its coming monetary policy SBP will make adjustment accordingly in line with actual data released instead of acting on mere anticipation/expectation, which did not prove correct.

Further, Pakistan has rightly adopted Stable Effective Exchange Rates policies, which suits our economy the best and hope it is likely to continue with the ongoing exchange policy rate stance and try to make amends on the economic front to correct weaknesses.

(Disclaimer applies in my post, which means that the perspective is my personal view. I have made every effort to ensure accuracy of information provided. However, accuracy cannot be guaranteed. This article is strictly for information and not intended for Trade or Business Transaction). 




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