Closing the open accounts and gham hour: Pakistan’s widening CAD problem

It can be said with certainty that at least one person has been having sleepless nights at the State Bank of Pakistan (SBP): The social media manager. Pakistan’s current account deficit clocked in at $1.2 billion for the month of July 2022 after dropping 45.45% month on month.

This sharp drop is enough to keep anyone up.

Ted Mosby, in the hit show How I met your mother is often found quoting his mom saying, “Nothing good happens after 2 am… when 2am rolls around just go home and go to sleep because decisions you make after 2am are the wrong decisions.”

The SBP’s decision to post about the sharp drop at around 2am on Thursday night was a wrong decision. For starters, it gave off the illusion that the SBP is trying to hide. Another way to look at it is that the SBP decided to post during gham hour, specifically due to the alarming situation at hand.

Why is the CAD made of nightmares?

The SBP says the decline in the CAD is primarily because of the sharp drop in energy imports and moderation in imports of other goods and commodities.

The SBP tweeted, “The narrower deficit is the result of wide-ranging measures taken in recent months to moderate growth & contain imports, including tight monetary policy, fiscal consolidation & some temporary administrative measures.”

However, it is alarming that the deficit is still fairly large despite the formal controls on imports in addition to the informal controls, such as the delay in LC processing. Despite all that, the CAD still managed to increase by 42% compared to last year.

However, despite the CAD worsening on a yearly basis and the reserves depleting, the rupee had been on a way of recovery having regained some lost ground until this week.

The foreign exchange reserves held by the SBP fell by $87 million bringing the reserves to $7.81billion on August 19, 2022. The import cover is hovering just above 1.1 months sending more cause for alarm.

This week, the rupee registered losses for four successive sessions against the dollar. The decline has been witnessed despite news of Qatar Investment Authority mulling investing $3 billion in Pakistan. In addition, news of $1 billion in assistance from Saudi Arabia will also provide support to the reserves.

This begs the question, why is the rupee depreciating – what is causing alarm?

Open accounts now closed

The SBP, in order to increase curbs on imports has proven to be counterproductive in terms of its spillovers. In a recent move, the SBP has instructed banks to limit their operations of open accounts, which has sent out a mayday signal regarding reserves and foreign exchange. 

An open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due. This makes it easy for importers to manage cash flow and cost.

Open accounts are one of the five major types of payment methods and terms. Others are cash in advance, letter of credit, documentary collection, and consignments.

By restricting open accounts, the SBP has created an element of panic within the foreign exchange market. “My clients have been using this form of payments for years. Their entire business model depends on it. Making changes like this only add pressure on the already fragile system,” said a banker while speaking to Profit.

Another added, “By coming out with another restriction, the SBP is giving a signal that the FX position in the country is weak. This is enough to send a panic sentiment and push the dollar to rally against the rupee.”

What this means is that although this move is done to control foreign exchange outflow, it effectively made it seem like the country does not have enough of it to meet its commitments. This was enough to cause the rupee to shed value. This situation is similar to July 2022 when the banks were unable to retire large fuel LCs making the market panic.

“As bankers we already have visibility on the slowing down of LCs, now cutting out another form of payments is enough to tell anyone that the situation is tough,” said a treasury employee at a leading bank.

For what it’s worth, banks are always jittery and anxious. The constant state of paranoia of losing out on other people’s money just makes them jump on every scare. However, the SBP should know how important a role sentiments play in the markets.