The removal of the US dollar cap by the Exchange Companies Association of Pakistan (ECAP) was a positive move, but analysts think it was a very bad idea.
The ECAP decided to remove the price cap on Tuesday in an effort to stop the market’s rising “artificial” demand for the dollar. The decision will be implemented immediately today (on Wednesday).
The State Bank of Pakistan’s official rate, the rate offered by exchange businesses, and the black market rate are the three rates at which the dollar is currently traded.
The association’s statement highlighted how the business was shifting from official to gray channels, harming not only the reserves but also resulting in losses to the exchange companies, and claimed that “there was artificial demand in the market as people would buy the dollar from us and sell it in the gray market.”
However, switching exchange businesses alone to market-based rates won’t be enough to close the significant price gap between the legal and illegal markets for dollars.
Although it’s a positive step, we must wait to see how the finance minister will react. According to Fahad Rauf, head of research at Ismail Iqbal Securities, the rate should ideally be set by the market in accordance with the requirements of the International Monetary Fund (IMF).
He said that the interbank rate ought to be determined by the market as well. If only exchange companies adopt market-based rates, it won’t be sufficient. To narrow the difference between official and unofficial rates, an interbank must also become established.
A lucrative black market grew as a result of the implementation of a cap. As more people use hawala and hundi, which provide better rates than the official rate, remittances have been declining. The artificial manipulation of the exchange rate results in a significant difference between the dollar interbank rate and the open market rate, which has an effect on official flows as more people turn to illegal methods of money transfer.
Due to a lack of supplies, the gray market is thriving. There are additional reasons why people favor the hawala system. Mamsa clarified that Bangladesh and Egypt might go through similar situations. The local currency in Egypt lost 22% of its value, but the difference with the black market remained constant. Similar to Pakistan, Bangladesh has experienced a decline in remittances at a similar rate.
He continued, “It’s a proactive step by the exchange businesses that can grow into an efficient medium of exchange and offer some market stability.