The shortage of physical dollars in the country is widening the gap between the open market and the interbank. Foreign exchange companies have devised a plan to bridge the gap between the open market and interbank rate.
During a meeting with Finance Minister Ishaq Dar and Advisor Tariq Pasha, the Chairman Exchange Companies Association of Pakistan (ECAP), Malik Boston shared an idea. He said that exchange companies have decided to bring in more dollars by making foreign trips in order to increase the domestic FX reserves, which will push the value of the rupee up.
Boston told Dar that exchange companies will ask overseas Pakistanis to help collect dollars which will then be sent back to Pakistan through official channels. According to Boston, this will help bridge the gap between the open market and the interbank that is trading at a spread of more than 10%.
The growing divide in the interbank and open market rates penalizes people for using official channels to send money to Pakistan. Hawala and hundi operators offer a better rate based on the open market rate as opposed to the interbank rate.
As the open market is in a crunch for dollars; the hawala and hundi operations in the country further aggravate the supply shortage faced by it.
A reason for the growing divide between the two rates is primarily that in other countries, people only go to exchanges when they are traveling and need the other country’s currency. People don’t really buy and hoard physical notes of other currencies.
Logically, the open market rate increases when there is a demand for foreign exchange. This could be when people are traveling more, going abroad to study, or even when people are trying to dollarize their savings.
You might be thinking why there are two different rates. To understand this, let’s look at what the interbank and open market really are and why they’re two different markets.
As the name suggests, the interbank market is a market between banks. On an international level, it is a network used by financial institutions to trade currency and currency derivatives with each other. These transactions can be on behalf of third parties done through banks; however, they are primarily done for the banks themselves.
Since May 1999, Pakistan has been following a market-based flexible exchange rate system. As a result, the interbank rate is applicable to all foreign exchange receipts and payments. This is for the private and public sectors. The exchange rate depends on the demands and supply conditions in the domestic interbank.
The interbank is fed by inflows such as imports, remittances, grants, aid, donations, foreign direct investment, and repatriation of profits. Any money that comes into the country through these official channels comes in through commercial banks for their clients. This feeds the interbank.
At first glance, you’re probably thinking that these two markets are vastly independent and do not rely on each other. That is not entirely true. Foreign exchange companies deposit or surrender their net inflows to the interbank at the end of trading days. That makes them a part of the system.
There is usually a differential or spread between the two rates. This is primarily because the exchange companies, while not always charging a commission, charge a margin so that they make money.
As a result, the interbank and open market are two different rates. In normal circumstances, the difference between the two rates is small, however, in times of volatility, the spread may grow. Sometimes, however, the interbank rate is higher than the open market rate. This is very rare but has happened.
Similarly, outflows are also made through this category. Depending on the need of the market, the SBP can inject liquidity by selling foreign currency in the interbank. It can also wipe up liquidity by buying.
As a retail buyer, you do not have access to the interbank rates. Instead, you go to the open market for all your foreign currency needs. The open market in Pakistan, or kerb market, primarily consists of Foreign currency exchanges where individuals can go buy and sell currency.
The open market, however, gets its inflows through remittances, travelers exchanging notes, and sometimes savers exchanging the currency they’ve held on to. You may be confused about remittances being an inflow in both the interbank and open market. This is because customers have the option to decide which channel to send their remittance from.
Why is the open market rate so high these days?
There are numerous signs around that show there is a dollar shortage. For starters, in the most recent update by the State Bank of Pakistan (SBP), Pakistan is yet again at its lowest level of Foreign Exchange reserves, in the last 8.5 years. In a consistently declining trend since October, the state bank’s liquid foreign exchange reserves have slid to a dangerous $5.576 billion. The FX reserves with banks also slid by 39 million dollars leaving Pakistan’s total liquid FX reserves at $11.42 billion.
To add to this very obvious shortage, all of the FX reserves with banks in the country are not present in physical form.
Let’s use an example to illustrate this.
Let’s say a bank processes a payment for a company. The company’s client sends the payment to the bank. The bank gets dollars deposited in its nostro account, it then converts the dollars to rupees and drops it in the customers account.
In today’s digital age, while one can say the payment of dollars is made, the importer has not really sent back physical dollars to the Pakistani bank. It is a virtual payment that is settled internationally.
This is standard practice. In normal circumstances, you wouldn’t even wonder about this. However, because there is a shortage of physical notes; the gap between the open bank and intermarket may be bridged partially by dealing with the issue.
So is Boston a genius?
At first glance, Boston’s idea of bringing back physical dollars through international trips might sound like a great idea but there’s a major caveat one needs to address first – Who would buy Pakistani rupees internationally? It’s not like there are tons of tourists and businessmen flying into the country; nor is the currency seen as the strongest of havens where people like to park their savings in.
It is a standard practice for exchange companies to gather all their illiquid currency and convert it to dollars in the UAE and bring them back. If Boston is referring to this as a solution, the extent of illiquid currency coming into the country is too low for this plan to work.
Moreover, the legality of flying in rupees is also a problem. International travel does not allow individuals to carry beyond $10,000; nor are people allowed to be mules to carry currency. Also, the cost of visas and airline tickets also put a burden on the currency and its cost.
This makes this scheme effectively just a gimmick, unless suddenly investors abroad want to stock up on PKR.
Dolor has become a big drama in the world. World economist must take good step for the replacement of this currency.
Daronomics at its best. Dress up the problem so its doesn’t appear to be a problem, just a mere inconvenience.
The pinnacle of daronomics. Dress up the issue so it doesn’t seem like a problem, just a little annoyance.