OPINION
Uzair Younus
The futility of exchange rate curbs
market quickly believed that all internet stocks were like the leaders, which then fueled a dramatic boom cycle in internet stocks. But the party did not last forever, and the stocks came crashing down. But the stampede was such that the market did not distinguish between good and bad internet stocks and companies across the board in the technology sector took a drubbing, from which they took years to recover. The nature of markets around the The ongoing flight to the dollar’s safety in Pakistan is being world is such that a few developments fueled by weak economic data and uncertainty in the markets. This is fueling speculation, but policymakers including the central bank result in a snowball effect must share some of the blame, given their inconsistent messaging and approach to policy. he State Bank of Pakistan is taking no prisoners on But let’s save that argument aside for another day. the foreign exchange market as it continues to pursue The fact of the matter is that the demand for the dollar is measures that seek to stifle the flight to the U.S. dollar strong, and the market is expecting sustained weakness in the rupee in the country. After placing biometric requirements on – market participants I have spoken to argue that the dollar exchange foreign exchange transactions, the central bank has also rate is going to hit 200 in the coming weeks. Whether this predicmoved to limit purchases of dollars through exchanges tion is right or wrong does not matter, because once enough people at $10,000 per day and $100,000 annually in the form of cash or remitbelieve that this is where things are headed, a self-reinforcing cycle tances sent abroad. This, the argument goes, ought to reduce the flight kicks in. to the dollar’s safety in the markets, where finding the greenback has In such a situation, action by the central bank to further curtail already become quite a challenging task. the flight to safety only fuels further panic and speculation. After Some are arguing for more action in the coming weeks, including all, if the central bank is concerned about this, then things must be a “tax on credit card spending outside Pakistan” with the argument beawful and are about to get a whole lot worse. This line of thinking ing that Pakistanis “need to tighten belts as a nation.” But what if these would make rational market participants to be the first ones to flock measures, while well-meaning on paper, exacerbate the very challenges to safety. And as they flock to safety, the very thing that the central the country is facing as it relates to the flight to the dollar’s safety? bank is seeking to prevent happens. Which then reinforces the view Understanding why these choices might be counterproductive that the rupee is weak, which then means more flight to safety, and I requires us to better assess how markets operate and the ways in think you get the picture by now. which herd mentality, especially amid a weak economic environment, During this entire cycle, the central bank’s curbs in the official sows panic and initiates a stampede towards the exits. market means that demand for the dollar is being fulfilled by the The nature of markets around the world is such that a few develinformal market, since it is hard to get a hold of the currency due to opments build momentum, creating a snowball effect which culminates the bank’s regulations. The growth of the black market would further a massive move to the upside or the downside, depending on where accelerate the flight to safety, primarily because the informal market momentum is building. This is how the dotcom boom and bust in the would demand a premium over the official exchange rate. This premilate 1990s, for example took shape: internet stocks were the new hot um, which would grow as more curbs are placed by the bank, would thing with companies like Yahoo! and eBay leading the revolution. The again be a signal to the market that it is only a matter of time before the rupee depreciates further. And this signal then further accelerates the flight to safety cycle described above. In sum, while the central bank’s decision to curb the market’s demand for dollars may sound great on paper, the fact of the matter is that these actions would only accelerate the dollarization of the economy. EvenThe writer is Director tually, more wealth would find its way into the black economy, meaning that by the time regulators wake up of the Pakistan to what has happened, they would have to dust off the old playbook and offer, you guessed it, another amnesty Initiative at the scheme to bring assets back into the formal economy. Atlantic Council, a My advice to the central bank and folks arguing for more “belt-tightening” is as follows: before you go Washington D.C.down this disastrous path, conduct an internal assessment on how such curbs would play out in the market. based think tank, and This can be done by engaging with market participants, learning from history and other countries, and better unhost of the podcast derstanding the underlying factors fueling the flight to the dollar’s safety. Based on this analysis, much of which Pakistonomy. He should be shared publicly, the central bank can take appropriate actions that deal with the root causes, not the tweets @uzairyounus. symptoms as evidenced by market developments.
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