Thursday July 25, 2024

Removing cap: How it affects the exchange rate in open market

By Our Correspondent
January 25, 2023
Packs of fresh $20 notes being processed at the US Treasury. — AFP/File
Packs of fresh $20 notes being processed at the US Treasury. — AFP/File

KARACHI: The Exchange Companies Association of Pakistan (ECAP) decision to remove a price cap it was using to sell and buy dollars in the open market is a positive step, but only exchange firms switching to market-based rates won't be enough to close a vast price gap between the official and unofficial markets for dollars.

Analysts viewed that ECAP decision capping the dollar price had been extremely unfavourable.

Fahad Rauf, head of research at Ismail Iqbal Securities

“It is a good step but need to see how finance minister will react to this. Ideally, the rate should be market determined as per IMF requirement,” said Fahad Rauf, head of research at Ismail Iqbal Securities.

The interbank rate should also be market determined, he added. “Only exchange companies shifting to market based rates won't be sufficient. Interbank also needs to come up to narrow the gap between unofficial and official rates.”

The imposition of a cap led to the emergence of a lucrative illegal market. Remittances have been decreasing as more people use hawala and hundi, which offer better rates than the official rate. As more people are transferring money using illegal means, artificially controlling the exchange rate has resulted in a significant disparity between the dollar interbank rate and open market rate, which is impacting official flows.

Faisal Mamsa, CEO of Tresmark

“The grey market is flourishing because demand is outstripping supply. Also, there are other reasons why people prefer the hawala system. In our opinion the impact will be negligible,” said Faisal Mamsa, CEO of Tresmark.

Mamsa explained that similar situations could be seen in Egypt and Bangladesh. “Egypt’s local currency depreciated by 22 percent, but the gap with the informal market remained the same. In Bangladesh, remittances have dropped at almost the same pace as in Pakistan.”

“However, it’s a proactive measure by the exchange companies that can evolve in to an efficient medium of exchange and bring some equilibrium in the market,” he added.