Daily Times

“Well, don’t, soldier. Pull a rabbit out of your hat…That’s the secret of both trial law and life,” said Denny Crane, from the television serial Boston Legal. And that’s exactly what the government did with the rupee — they pulled a rabbit out of the hat.

Now that the catchy title, which hopefully enticed people to read on, is identifiable, in so far as clarifying that this is not an article on the animal kingdom, all one needs to deliberate on is the rabbit. As pointed out by Denny, pushed to a corner with no other options, the only solution is magic, pulling a rabbit out of the hat, and apparently beyond trial law and life, magic is equally useful in fiscal management. Pulling down the rupee-dollar exchange rate by about six rupees in less than two weeks is nothing short of magic, especially since ground realities remain unchanged. In all probability, money traders will be kicking themselves in the nether regions for having missed the bus, except obviously for those who were farsighted.

How does that work? Well imagine that a trader borrowed $ 100 just before the dip and sold it when the rate was Rs 105 and waited patiently for the next 10 days. When the dollar hit Rs 99, this hypothetical trader buys back the dollars and pays off his loan, thereby pocketing a neat Rs 600 for his efforts, notwithstanding a meagre borrowing cost. And note that traders operate with millions of dollars. The amount of money that could have been made with a bit of hard work runs into millions. One is reminded of J Paul Getty’s axiom, “Rise early, work hard, strike oil.”

One is rather unsure of the rising early and working hard parts, but the striking oil part is evident. Clearly the funds have their origins in oil, as today’s headlines say that the government has informed the International Monetary Fund that $ 1.5 billion were received from the Saudi government via the Pakistan Development Fund. The latter must rise very early and work very hard to have struck that much oil; irrespective of their work habits, their generosity is appreciated. On the other hand, there are no free lunches in the real world; there has to be a cost. Conjecturing on the costs is better left to more competent political analysts, but frankly everything is pure speculation, at least for now.

Getting back to the good fortune of this useful and timely gift of $ 1.5 billion: there is confusion about whether this remittance alone could have had such a significant impact on the rupee-dollar parity. Realistically, yes; however, the tremors should have been of a much lower intensity over a much longer period. Currency markets, like any other markets, work on the basis of supply and demand. In Pakistan’s case, in the light of our sizeable trade imbalance, even after accounting for equally sizeable workers’ remittances, the rupee is expected to remain under pressure. However, gifts like $ 1.5 billion out of the blue definitely change perceptions and let’s hope there is more where that came from. But while these do boost reserves, for the market to behave in such a manner, someone must have been selling dollars, and a lot of them, in a very short time. The motivation behind this action remains debatable, but to borrow from Dan Ariely, is also ‘predictably irrational’.

The rumour mongers (we must rely on them since accurate data is not readily available) peg the abnormal sale of dollars at around 200 million in this period, which the government classifies as remittances from funds held abroad by exporters pursuant to the formers’ efforts. This is all very good except that this simultaneous influx has exposed the rupee’s inherent volatility to those traders who believe in long positions. Logically, if above-normal sales of $ 200 million can appreciate the rupee by six rupees, imagine what above-normal purchases of $ 400 million could do to the parity rate. And rest assured, money traders are devoid of any morals whatsoever.

And how does a long position work? Exactly opposite to the short. The proverbial trader borrows in rupees and starts buying dollars in the market. Assuming a large enough quantum of buying, the rupee starts to depreciate and at the target profit of say five rupees, this hypothetical trader sells the dollars to pay off the loan and pockets the profit. A layman would logically conclude that if the same amount is bought and sold, the price should move in exactly the same proportion and therefore any gain should be impossible. Correct; unfortunately any speculative play like this invariably fools the small investors who — unable to fathom the ground realities — jump in out of fear of losing their life savings in the case of appreciation, or out of greed to make gains in the case of devaluation. Unfortunately for them, they are the last to get in and worse still, the last to get out, and the traders fully understand this.

But in theory at least, all is not lost for small investors, since there is a guardian of the financial world generally known as the central bank, charged with the responsibility, amongst others, of countering the nefarious designs of shady speculators. Albeit it is not out of benevolence that the central bank protects small investors; the real motivation is that a yo-yoing currency is a risky proposition for a nation’s current account, and especially risky for exports in the case of a developing country like Pakistan. However, there are other predictably irrational reasons for action or inaction by central banks, which perhaps explain why the currency was allowed to shift in this recent episode.

The reason that exporters lose when the domestic currency appreciates is because they become uncompetitive. Assume that the exporter was previously selling his product in the international market for $ 100; this meant that his rupee earnings were Rs 10,500. When the rupee appreciates, his rupee earnings fall to Rs 9,900, at which price he may not be profitable. To remain profitable at the previous level, he would have to sell at $ 106 to get the same rupee earnings, which may be difficult in a highly competitive international market. But shame on the exporters for complaining, because when the rupee appreciates, imports become cheaper! This means that the price of branded items and luxury cars go down and Pakistanis can continue to live beyond their means forever more. And shame on the hoarders who were waiting for prices to go up in expectation of the rupee devaluating.

To conclude, what then is the uptake on the rupee going forward? A friend who has to remit dollars for his child’s education is struggling with the decision to wait or buy. Obviously he is elated and swears to vote for the ruling party forever if the dollar falls to Rs 80. Frankly, in an uncertain environment where dollars can continue to materialise out of nowhere and oil payments can get deferred, even the best of the best traders will be wary. For the small buyers, at the end of the day, hope for the best and pray for the rest.

The writer is a chartered accountant based in Islamabad. He can be reached at syed.bakhtiyarkazmi@gmail.com and on twitter @leaccountant