Enigmatic exchange rate (2024)

IS our exchange rate ‘market-determined’ nowadays? Its stability — around Rs280 to one US dollar — appears both amazing and perplexing in the current difficult balance-of-payments situation. This remarkable stability reportedly helped the State Bank of Pakistan purchase billions of dollars from the interbank foreign exchange market over the last few months. Earlier, in the first half of FY2024, the rupee first depreciated from Rs282 to Rs333 within two months, ie, July-August 2023, and then appreciated in the open market back to around Rs280 during September-October. This behaviour brought about by economic and non-economic forces, with few fluctuations since then, helped the SBP increase its dollar reserves through purchases.

During a period of high volatility in the open market, the interbank rate fluctuated much less (between Rs276 and Rs307.) Resultantly, the difference between the open market and interbank rate went up from around zero to about Rs27 in September 2023. The appreciating pressure both in the open and interbank market flooded the former with dollars, causing the open market premium to crash — again close to zero. This much-needed supply helped the SBP purchase dollars to shore up its reserves during the appreciating trend. This purchase is the opposite of the practice of keeping the exchange rate stable by selling from SBP reserves to the interbank dollar market.

Economists usually label a non-moving or little-moving exchange rate as ‘fixed’, ‘pegged’, or a ‘de facto peg’, if the official position runs contrary to the apparent fixity. Economists also use the intelligent term ‘fear of floating’ to indicate a failure to establish a truly market-determined exchange rate. So, what is the reality regarding our current exchange rate regime? Does it exhibit a fear of floating? If it does it would indicate that it is not truly market-determined.

The price of the dollar to the rupee is brought about by the complex interaction between market forces, the regulator of foreign exchange (the central bank), and the government (usually the finance ministry). Dollar demand is influenced through economic incentives given to importers (and outward remitters), and several regulations enshrined in the Foreign Exchange Regulation Act, 1947. Dollar supply is determined by economic incentives to industry, especially export sectors and inward remitters. In terms of ‘wishes’, everyone — consumers of imports (petrol and non-petrol), outward remitters, the government, smugglers, money launderers, etc — would ‘like’ the price of dollar to be extremely low. The only exceptions are exporters (who are not importers) and receivers of inward remittances.

Have our authorities succeeded in inventing a new kind of exchange rate regime altogether?

However, reality does not function on wishes alone. Any price determination regarding demand and supply requires either purchasing power, or another kind of power to influence the price (in the short run). This determines the actual price. A persisting trend of supply being lower than demand will dictate the market regarding price flexibility, with the exchange rate ultimately overshooting.

In our foreign exchange interbank market, those on the supply side are exporters, importers, and the treasury heads of banks who facilitate interbank transactions. The power of facilitators is limited by the supply of foreign exchange they receive daily from exporters and remitters, and partially on their market-making or intelligent price-quoting skills. Rarely, big bankers may collude to dictate a higher price, but this behaviour is unlikely to be sustained as the biggest player is the central bank, which can check manipulative behaviour through regulations, penalties, or a surprise supply of dollars in the interbank market to reduce the dollar’s price.

So, what happened to the exchange rate at the beginning quarter of FY24? According to the SBP’s latest half yearly report, “During Jul-Aug 2023, the external sector was facing several challenges, such as increasing financing gap, high volatility in FX market, tightening of global financial conditions, and heightened domestic uncertainty. These adversely impacted forex reserves and increased pressures on exchange rate. However, crackdown on illegal currency activities like smuggling of foreign exchange, besides exchange company reforms introduced by the SBP in September 2023, reduced pressures on the exchange rate. This combined with sustained improvement in current account balance and reserve position following disbursem*nts from other bilateral and multilateral sources, led to a gradual appreciation of PKR from 5th September 2023 onwards. Supportive regulatory measures, like the imposition of a processing fee on Afghan imports of transit commercial goods via Pakistan and the suspension of B-category exchange companies’ authorisation, further alleviated the strains in the FX market.”

The ‘crackdown’ referred to here became both domestic and international news. Wikipedia now has a page about the 2023 crackdown. Last September, Dawn reported it as ‘The dollar galore in grey market’ and ‘Crackdown restores confidence in rupee’. The ‘crackdown’ on unscrupulous open-market elements rapidly brought down the value of the dollar. The mere news about the crackdown must have reverberated through banking circles deeply affecting the psyche of commercial bank presidents, and appearing to influence treasury officers’ dollar price-quoting behaviour also. Now that the SBP is not supplying dollars in settling their daily trades determining the exchange rate, can we say that it is a market-determined exchange rate? One can say that it seems more like a ‘crackdown-determined’ exchange rate. Have our authorities succeeded in inventing a new kind of exchange rate regime altogether? According to a report on May 7, “A nationwide crackdown on elements involved in hundi and illegal currency exchange persists, as reported by the spokesperson of the Federal Investigation Agency. Over the past four months, 267 raids were conducted targeting individuals engaged in the illegal exchange of hawala, hundi, and illegal currency exchange businesses.”

According to the assessment of the IMF staff published in their May 2024 report, “Gross debt-service obligations remain substantial, and current account imbalances stemming from insufficient exchange rate flexibility and import restrictions may require additional policy adjustment to reach external equilibrium.” Are we about to see a move towards market-determined exchange rates in the near future as we negotiate a medium-term programme with the IMF? If that is so, the future will reveal how long it lasts, given our fixed (and lower) exchange rate-loving authorities and people.

The writer is a former deputy governor of the State Bank of Pakistan.


Published in Dawn, May 25th, 2024

Enigmatic exchange rate (2024)


Enigmatic exchange rate? ›

The real exchange rate (RER) between two currencies is the product of the nominal exchange rate (the dollar cost of a euro, for example) and the ratio of prices between the two countries.

What is the difference between nominal exchange rate and real exchange rate? ›

The real exchange rate (RER) between two currencies is the product of the nominal exchange rate (the dollar cost of a euro, for example) and the ratio of prices between the two countries.

What is the strongest exchange rate? ›

Kuwaiti dinar

You will receive just 0.30 Kuwait dinar after exchanging 1 US dollar, making the Kuwaiti dinar the world's highest-valued currency unit per face value, or simply 'the world's strongest currency'.

What is manipulation of exchange rates? ›

Currency manipulation is a policy used by governments and central banks of some of America's largest trading partners to artificially lower the value of their currency (in turn lowering the cost of their exports) to gain an unfair competitive advantage.

What is an example of a floating exchange rate? ›

An example of a floating exchange rate is USD/JPY, trading at 140. This shows that every U.S. dollar is exchanged for 140 Japanese yen.

What are the two types of exchange rates? ›

Exchange rates of a currency can be either fixed or floating. Fixed exchange rate is determined by the central bank of the country while the floating rate is determined by the dynamics of market demand and supply.

What is nominal rate vs actual rate? ›

The nominal interest rate, or coupon rate, is the actual price borrowers pay lenders, without accounting for any other economic factors. The real interest rate accounts for inflation, giving a more precise reading of a borrower's buying power after the position has been redeemed.

What country is the US dollar worth the most? ›

What country is a dollar worth most? Some of the countries where a dollar is worth the most money include Mexico, Peru, Chile, and Colombia. It's possible to exchange dollars for local currency in these countries at favorable exchange rates.

Where is the American dollar worth the most in 2024? ›

Japan continues to be a popular choice, but Vietnam and South Korea stand as solid alternatives among numerous countries in Asia with favourable exchange rates for the US dollar. Closely following in value are South American countries: Argentina and Chile are among those offering the biggest luxury bang.

What is the weakest currency in the world? ›

What Is the Weakest Currency in the World? The weakest currency in the world is the Iranian rial (IRR). The USD to IRR operational rate of exchange is 371,992, meaning that one U.S. dollar equals 371,922 Iranian rials.

How to know if an exchange rate is good? ›

A good exchange rate means you get the most value for your money during a currency transfer. To determine what's “good,” you must understand what's normal by checking the mid-market rate. This term refers to the midpoint between the buy and sell prices of any two currencies across different vendors and banks.

How do banks manipulate currency? ›

Markup fees: Banks apply an additional fee to the exchange rate, making it more expensive for businesses and customers. Rate manipulation: Banks manipulate exchange rates to their advantage by giving their customers a worse exchange rate than what they would get on the open market.

Which countries are currency manipulators? ›

Since the 1988 Act was enacted, the United States Department of the Treasury has designated the following countries as currency manipulators:
  • South Korea in 1988.
  • Taiwan in 1988 and again in 1992.
  • China from 1992 to 1994.
  • India was added to the list in 2017 for 'questionable foreign exchange policies'.

How is currency backed by gold? ›

The gold standard is a monetary system in which the value of a country's currency is directly linked to gold. With the gold standard, countries agree to convert paper money into a fixed amount of gold. A country that uses the gold standard sets a price for gold, and it buys and sells gold at that price.

What is the dirty float exchange rate? ›

A dirty float is a floating exchange rate where a country's central bank occasionally intervenes to change the direction or the pace of change of a country's currency value. A dirty float is also known as a "managed float."

What does pegging the exchange rate mean? ›

The term pegging refers to the practice of attaching or tying a currency's exchange rate to another country's currency. Pegging often involves preset ratios, which is why it's called a fixed rate. Pegs are often put in place to provide stability to a nation's currency by linking it to an already stable currency.

What is the difference between a nominal exchange rate and a real exchange rate quizlet? ›

A nominal exchange rate measures the value of one country's currency in terms of another country's currency. A real exchange rate measures the price of domestic goods in terms of foreign goods.

What is the difference between nominal and real conversion? ›

The nominal value of any economic statistic means the statistic is measured in terms of actual prices that exist at the time. The real value refers to the same statistic after it has been adjusted for inflation. Generally, it is the real value that is more important.

What is the difference between exchange rate and real effective exchange rate? ›

Is there any difference between the Real Exchange Rate and Real Effective Exchange Rate? The real exchange rate is the cost of a particular product or asset in a different currency. The real effective exchange rate is the relative rate of exchange with respect to a basket of trade currencies.

What is the difference between nominal and real dollars? ›

In economics, the nominal value of something is its current price; the real value of something, however, is its relative price over time. Both can be used to talk about the value of not only money, but also your wages, share prices and other things that have financial value.

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