Dollar demand remains high despite interest rate hikes

KARACHI: The massive hikes in the interest rate in recent months have had no impact on the exchange rate as the demand for dollars by the importers remained robust which kept the local currency under constant pressure.

The State Bank of Pakistan has been delivering policy rate increases since September 2021 with a key objective to check the surging inflation — which hit over 21 per cent in June — and cool down the economy by curtailing the imports which continued swelling despite several measures.

The central bank on Thursday again increased its policy rate by 125 basis points to 15 per cent.

A high-interest rate directly impacts the exchange rate since it makes money costlier for importers and other buyers lowering the demand which depreciates the greenback. As a result, the importers have to borrow costlier money from banks while they purchase dollars at higher rates to clear their import bills.

Despite this double negative impact, the country’s imports showed no respite and soared to $80 billion in FY22.

“The latest increase in the interest rate would not stop the race for higher imports which means the dollar demand will remain high with increasing prices,” said Zafar Paracha, General Secretary of Exchange Companies Association of Pakistan (ECAP).

He said the market did not react to interest rate hikes as the imports kept increasing despite costlier money which means other important factors need to be addressed.

On May 19, the PML-N-led coalition government banned the import of luxurious and non-essential goods to curtail the import bill to save fast depleting foreign exchange reserves.

The market sources said the import ban is being removed gradually while several items have already been removed from the list which was one of the reasons for higher imports in June.

However, the government has yet not officially announced the elimination of luxurious items from banned imports.

The dollar started appreciating, after losing against the rupee, with the inflow of $2.3 billion from China. During the last two sessions, the dollar appreciated by Rs1.31 and Rs1.05 which eroded the positive impact of Chinese loans.

A senior banker said the sudden increase in the dollar prices was due to State Bank’s clearance of all pending requests for opening of Letters of credit. He said the central bank has restricted importers to get prior permission from the SBP for the opening of LCs of $500,000 and above.

“All pending requests for opening of LCs were cleared within a few days. It was not illegal but was critical since we are standing at the door of crisis,” said the banker.

The former finance minister Shaukat Tarin claimed that the country is heading towards default. Currency experts did not agree but said the situation is critical and will be worse if the IMF further delays the tranche of $1bn.

The finance minister Miftah Ismail claims talks have been completed but the delay in the release of tranche is creating doubts.