The Looming Currency Crisis in Pakistan & the State Bank's Dilema
by, 03-Jun-2012 at 01:49 AM (1379 Views)
The Looming Currency Crisis
Asif Punjwani on 1, Jun 2012
In my previous article, I had stated that Rupee will see a 15% depreciation before or by summer. Summerís here! But the 15% depreciation isnít. Congratulations Pakistan! You have dodged the forex bullet. Thereís egg on my face for calling the wrong shot. Lekin picture abhi baaki hai mere dost!
So where did I go wrong? You see things have truly worsened in the past few months. But just one simple factor which I had failed to assume, delayed the outcome. That was the price of Brent-Crude Oil. From a position of burning billions of dollars importing crude at $125/br and selling electricity at subsidized cost, Pakistan went to making money due to the recent fall in Oil Prices, about $103/br. This event has simply delayed the looming far severe crisis in Pakistan Rupee.
Ever wondered why State Bank of Pakistan has Interest rates set at 12%, while the rest of the countries have their rates from 5~8%? Who is SBP competing against for International Capital, setting rates at 12%? Iíll share the unofficial reason. State Bank has set the rates so high because it doesnít want George Soros to come in, borrow Rupee and start dumping that Rupee in the Forex market to buy dollar, betting that by doing so *Soros would drive down the value of Rupee against the dollar. And in the end, he would buy back the Rupees (at a much cheaper rate) he had borrowed and settling his borrowing. *Soros doesnít do it because borrowing Rupees at 12% will only be profitable if Rupee depreciates to over Rs100 for a dollar (in a year).
*Disclaimer: Soros represent external hedge fund activities
Since last October, State Bank has seen its ďNetForeignAssetsĒgoneinnegativeterritory. This means State Bank has no equity in foreign assets. Sure there is a $16 Billion reserve but that creates the base foundation of the Rupee. Once the foundation erodes, so does the value of the rupee against the dollar. Another way to look at the negative NFA position is that the State Bank borrowed foreign assets and sold them cheap. To return the borrowed foreign assets again, State Bank would have to buy the assets back at a higher rate. This is akin to a Ďnaked short positioní. Add the risk of devaluation to it and you have an explosive situation!
There has been another story brewing in the Pakistani REPO Market. State Bank has been increasingly stepping in to buy back Govt debt to prop of the values of these Govt Bonds. Since the start of 2012, SBP has purchased over Rs1.5 trillion of debt from the Commercial banks. This Rs1.5trillion came from computer keystrokes Ė electronic credit. Itís the same as printing notes, just cheaper Ė much cheaper!
So why is the State Bank giving money to the Commercial Banks? You see Pakistan Banking sector is up to its eyeballs in Government Bonds. When inflation ticks up(currently 11% officially), banks will be forced to dump these bonds paying 12% interest for higher yields to save their capital. When that happens, values of these bonds will come down. Since these Govt bonds make the capital reserves of Banksí balance sheets, banks will lose their capital cushion, rendering many insolvent. To avoid this, SBP is propping up Govt Bond prices to keep the banks from crashing. But SBP cant continue this for long because it risks devaluing Rupee. SBP will find itself cornered, whether to save the banks or the Rupee.
Iíll try to end this with some hopes of good signs. Itís possible. Either, I could turn out to be wrong. Maybe the Government will fix its budget deficit, Pakistan economy will fix its trade deficit and IMF will forgive Pakistanís debt, all in the next 6 months! Itís possible, right after the hell freezes overÖand over! Till then buyer beware.
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