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Weak rupee calls for forceful central bank action

SINGAPORE: After months of withstanding intense political turmoil and a deteriorating trade balance, the tipping point for Pakistan’s rupee proved to be a heavy bout of dollar buying and insufficient support from the central bank.

The currency plunged 6.3 per cent last week, hitting a record low on Friday and forcing the State Bank of Pakistan to step in and staunch its decline. But analysts say the respite the rupee has won will be short-lived and the central bank needs to be far more forceful in its intervention to merely ensure the rupee slides gradually rather than goes into a free-fall.

The trade deficit is rising at a faster pace than many analysts had expected and the current account gap stands at about 6 per cent of economic output. The political situation continues to be murky despite some indications on Monday that the main partners in the coalition government will stick together.

More worrisome is the sense in financial markets that the central bank has been too slow to respond to inflation when it scaled multi-year highs and to the rupee’s slide last week. “With such a large trade and current account deficit, it is difficult to suggest that the pressures on the rupee will go away without entral bank intervention,” said a Karachi-based analyst, who refused to criticise the central bank on record.

The central bank promised increased market surveillance and intervention on Monday and on Friday it was suspected of selling dollars. It also issued a statement warning against speculation, and telling market participants they could expect inflows of up to $3.5 billion in the short term.

“I don’t know why they didn’t intervene earlier,” the Karachi trader said, adding that the rupee would recover only when market faith in the central bank’s readiness to defend the currency was restored.

Analysts suspect the State Bank of Pakistan was trying not to expend its limited currency reserves, although it might have waited until it was too late. As of early May, reserves held by the State Bank of Pakistan were down to $9.9 billion, down from a peak of $14.2 billion in November.

A good portion of that could have been spent on markets during the rupee’s roller-coaster ride through last year’s emergency rule, general elections in February and the wrangling of the coalition partners thereafter.

Panic: No one is quite sure why the rupee plunged from levels near 65 to as low as 69.47 per dollar last week. Currency market traders say much of the rupee-selling was driven by domestic speculators and importers, and foreign portfolio outflows were relatively small.

The stock market (KSE) has indeed been resilient, falling just 3.7 per cent so far this year against the rupee’s more than 10 per cent dive.

Traders suspect the rupee succumbed to a panic attack as oil prices climbed to a record $126 a barrel and importers scurried to hedge their exposures. Data released on Saturday showed the trade deficit doubled to $2.29 billion in April from a year ago.

That probably unnerved local businesses, many of whom might have scrambled to hedge short-term dollar borrowings from banks, which are estimated at nearly $2 billion. “There were outflows in the market for the last couple of days and everyone was expecting the central bank would intervene but then when they did not come into the market, there was a bit of panic,” said one trader in Karachi.

The politics certainly is not helping the rupee either. Policy-making is in limbo at a time when the country needs to tackle rising food prices, slowing growth on account of the US mortgage crisis and ballooning government expenses.

“The worry in Pakistan is that there is going to be loss of confidence onshore for political reasons and central banks are not in a position to block a loss of confidence stemming from political reasons,” said ING economist Tim Condon.

For now, analysts say, the central bank should raise rates quickly, to stem both the currency’s fall and inflation, while also intervening regularly to supply the dollars the market needs. “We think the more likely policy response would be for the central bank to let the rupee weaken, albeit more gradually, and tighten monetary policy further,” said Deutsche Bank strategist Mirza Baig.