Pakistan’s economy has faced a number of challenges in recent years, including high inflation, a large trade deficit, and a devaluation of the Pakistani Rupee. These situations have created an economic crisis in Pakistan. To address these challenges, the government has implemented a number of monetary policy measures to control the exchange rate of the Rupee. 

Government controls the dollar rate in the Pakistani local market to artificially control the inflation and trade deficit. From interest rate adjustments to open market operations, the government has taken a number of steps to stabilize the currency and support the economy. In this discussion, we will explore the impact of these measures on the exchange rate of the Rupee and the broader economy of Pakistan.

Keywords:

Government of Pakistan, dollar rate controls, inflation, trade deficit, devaluation, supply and demand

The Role of the Central Bank in Controlling Supply and Demand of the Dollar.

The State Bank of Pakistan, is responsible for maintaining the stability of the country’s financial system, including the supply and demand of the dollar. The State Bank of Pakistan’s actions and policies have a significant impact on the exchange rate of the dollar in the country, which affects businesses, consumers, and the overall economy.

One of the main ways the Central Bank of Pakistan affects the supply and demand of the dollar is through its monetary policy. The bank can increase or decrease the money supply by adjusting interest rates, which in turn affects the exchange rate of the dollar. For example, if the Central Bank of Pakistan increases interest rates, this makes it more attractive for investors to hold Pakistani rupees, which increases demand for the rupee and decreases demand for the dollar. This, in turn, can cause the value of the dollar to decrease in relation to the rupee.

The Central Bank of Pakistan can also influence the supply and demand of the dollar through its foreign exchange reserves. The bank can buy or sell dollars in the foreign exchange market to stabilize the exchange rate of the dollar. For example, if the bank believes the value of the rupee is too high, it can sell dollars in exchange for rupees, which increases the supply of dollars in the market and decreases the supply of rupees. This, in turn, can cause the value of the dollar to increase in relation to the rupee.

Moreover, the Central Bank of Pakistan uses a managed float exchange rate system, which means the exchange rate is determined by market forces but the Central Bank can intervene to stabilize the rate if needed. This system allows the exchange rate to be relatively flexible, which can help the economy adjust to changes in the global market. However, it also means that the exchange rate can be subject to volatility and uncertainty.

Another factor that affects the supply and demand of the dollar in Pakistan is the country’s balance of trade. If Pakistan exports more goods and services than it imports, this increases the supply of dollars in the country, which can decrease the value of the dollar. Conversely, if Pakistan imports more goods and services than it exports, this decreases the supply of dollars in the country, which can increase the value of the dollar.

In addition, political and economic events both within and outside of Pakistan can also impact the supply and demand of the dollar. For example, political instability or a decline in economic growth can cause investors to withdraw their investments from the country, which can decrease the demand for the rupee and increase the demand for the dollar. Similarly, a rise in global oil prices can increase the demand for dollars in countries that import oil, including Pakistan.

In short, the Central Bank of Pakistan plays a crucial role in maintaining the stability of the financial system, including the supply and demand of the dollar. Its monetary policy, foreign exchange reserves, and managed float exchange rate system all play important roles in influencing the exchange rate of the dollar. However, there are other factors that can impact the supply and demand of the dollar, including the country’s balance of trade and external events. Understanding these factors is important for businesses, consumers, and policymakers in Pakistan.

Tools of Central Bank to Regulate The Dollar Rate

1. Interest rates

 Central banks can raise or lower interest rates, which affects the demand for the currency and its exchange rate. Higher interest rates are attractive to the foreign investors. But this is not good in the long run, as it traps locals in circular debts. In addition to this, If higher interest rates lead to lower inflation expectations, it can boost the currency’s value. On the other hand, lower interest rates and higher inflation expectations can lead to a decrease in the currency’s value.

Overall, the central bank’s decisions on interest rates can have a significant impact on the exchange rate of the currency, as it affects the demand for the currency and inflation expectations.

2. Open market operations

This is also known as monetary policy operation. Central banks can buy or sell government securities on the open market, which changes the money supply and affects the exchange rate. It also has a significant impact like interest rates. 

In case the central bank buys government securities, it injects money into the economy, increasing the money supply. This can lead to an increase in demand for goods and services, which can cause inflation to rise. To combat inflation, the central bank may need to raise interest rates, which can increase the demand for the currency and cause its value to appreciate.

On the other hand, in case the central bank sells government securities, it removes money from the economy and reduces the money supply. This leads to decrease in demand for goods and services and it also controls the inflation rate. To boost economic activity, the central bank may need to lower interest rates, which can decrease the demand for the currency and cause its value to depreciate. So interest rates and open market operations are aligned for inflation, interest rate and boost economic activity.

3. Currency intervention

Central banks can directly buy or sell their currency in the foreign exchange market to affect its exchange rate. it can directly affect the supply and demand of a currency. It actually determines the actual value of currency with respect to other currencies.

In case the central bank buys its own currency that will increase its supply in the market. It can lead to an appreciation in its value relative to other currencies. This can help to reduce the trade deficit, encourage exports, and stabilize the currency during periods of market turbulence.

On the other hand, in case the central bank sells its own currency, it decreases its supply in the market, which can lead to a depreciation in its value relative to other currencies. This can help to reduce inflation, curb imports, and stabilize the currency during periods of overheating.

In short, currency intervention can be used as a tool to influence the exchange rate of a currency and achieve specific economic objectives. However, it is important to note that currency intervention can also have unintended consequences, such as causing market turbulence, and should be used with caution.

4. Regulatory measures

This refers to the rules and restrictions on currency trading. Governments can impose restrictions on currency trading or capital flows to limit the supply of foreign currency and support the value of the domestic currency.  These measures can impact the exchange rate of a currency and are used to achieve specific economic objectives. There are some Examples of regulatory measures:

1. Capital controls: Governments can restrict the flow of capital in and out of the country to limit the supply of foreign currency and support the value of the domestic currency.
2. Foreign exchange controls: Governments can limit the amount of foreign currency that individuals and businesses can purchase or hold, which can impact the demand for the currency and its exchange rate.
3. Foreign exchange market intervention: Governments can directly intervene in the foreign exchange market to buy or sell their currency, similar to currency intervention by central banks.

Government policies and Dollar Rate is Connected: Example of Recent Past

Government intervention can have a significant impact on the exchange rate of a currency, such as the dollar. Governments can influence the demand and supply of the currency through direct interventions, such as buying or selling their own currency, as well as indirect interventions, such as monetary policies, trade policies, and the perception of foreign investors. Understanding how government intervention affects the exchange rate is important for businesses, investors, and policymakers who need to manage the risks and opportunities of currency fluctuations.

In the recent past, the Pakistani government has taken various measures to intervene in the foreign exchange market to stabilize the value of the Pakistani rupee against the US dollar. The following are some examples of Pakistani government interventions in the foreign exchange market:

1. Introduction of a market-based exchange rate system: In May 2019, the State Bank of Pakistan (SBP) introduced a market-based exchange rate system, under which the exchange rate was determined by the supply and demand of foreign currency in the interbank market. This replaced the previous system of fixing the exchange rate through the central bank, which was criticized for distorting the market and causing shortages of foreign currency.
2. Increase in interest rates: In July 2019, the SBP increased the key interest rate by 100 basis points to 13.25%, in an effort to control inflation and stabilize the value of the rupee. Higher interest rates can make the rupee more attractive to foreign investors, increasing demand for the currency and supporting its value.
3. Launch of Roshan Digital Accounts: In September 2020, the government launched the Roshan Digital Accounts program, which allows overseas Pakistanis to open bank accounts and invest in Pakistan’s stock market and real estate market. This program aims to attract foreign investment and increase the inflow of foreign currency, supporting the value of the rupee.
4. Extension of loan repayment period for exporters: In November 2020, the government announced an extension of the loan repayment period for exporters from 180 days to 360 days, in an effort to provide relief to exporters facing cash flow issues and support exports. This is expected to increase the inflow of foreign currency and support the value of the rupee.
5. Suspension of import of non-essential items: In June 2021, the government suspended the import of non-essential items, such as luxury cars and mobile phones, in an effort to conserve foreign exchange reserves and control the trade deficit. This is expected to decrease the demand for foreign currency and support the value of the rupee.

In short, the Pakistani government has taken various measures in the recent past to intervene in the foreign exchange market and stabilize the value of the Pakistani rupee against the US dollar. These measures include the introduction of a market-based exchange rate system, increase in interest rates, launch of the Roshan Digital Accounts program, extension of loan repayment period for exporters, and suspension of import of non-essential items. These interventions have had mixed results, with some measures proving to be effective in supporting the value of the rupee, while others have faced criticism for causing inflation and economic instability.

Impact and interaction of Market Forces with dollar rate, inflation rate, GDP and Government Policies:

The value of the US dollar against the Pakistani rupee is determined by market forces, including the supply and demand of dollars in the foreign exchange market. The interaction of these market forces with government policies plays a critical role in determining the exchange rate. Economic indicators such as inflation and GDP also have a significant influence on the dollar rate.

Market forces & Dollar rate

Supply and demand of dollars in the foreign exchange market determines the value of currency. When there is a high demand for dollars and a low supply, the value of the dollar increases, and vice versa. Dollar inflows  such as exports, remittances, foreign investment determine the supply of dollars. Dollars outflows such as imports, debt repayments, and the desire for dollar-denominated assets determines the demand for dollars.

Inflation

Inflation generally increases the level of prices for goods and services and decreases the purchasing power of a currency. High inflation decreases the value of the Pakistani rupee and the value of the US dollar increases. This is because a higher inflation rate indicates that the country’s currency is losing value, making it less attractive to foreign investors.

GDP

Gross Domestic Product (GDP) is the total value of goods and services produced in a country in a given period. A high GDP growth rate indicates a healthy and growing economy, which is attractive to foreign investors. This increased demand for the local currency can cause the value of the Pakistani rupee to appreciate, making it more expensive to buy US dollars.

Interaction of Market Forces with Government Policies

The Pakistani government can influence the dollar rate by implementing policies that affect the supply and demand of dollars in the foreign exchange market. The State Bank of Pakistan (SBP), Pakistan’s central bank, intervenes in the foreign exchange market by buying or selling dollars to regulate the supply of dollars and maintain price stability.

In addition, the government can also influence the dollar rate by implementing economic policies that affect the supply and demand of dollars. For example, if the government imposes higher tariffs on imports, it can reduce the demand for dollars in the foreign exchange market, thereby decreasing the value of the dollar against the Pakistani rupee. Conversely, if the government introduces policies that increase exports or foreign investment, it can increase the supply of dollars, thereby increasing the value of the dollar against the Pakistani rupee.

In short,  the value of the US dollar against the Pakistani rupee is determined by market forces, including the supply and demand of dollars in the foreign exchange market. Economic indicators such as inflation and GDP also have a significant influence on the dollar rate. The interaction of market forces with government policies plays a critical role in determining the exchange rate. The Pakistani government can influence the dollar rate by implementing policies that affect the supply and demand of dollars, such as through the intervention of the State Bank of Pakistan or by introducing economic policies that affect the demand for dollars.

Conclusion 

The exchange rate of the US dollar against the Pakistani rupee is a complex phenomenon influenced by multiple factors, including market forces and government policies. The market forces of supply and demand determine the exchange rate, and economic indicators such as inflation and GDP also play a crucial role. The Pakistani government can intervene in the foreign exchange market to influence the exchange rate through its monetary policies and foreign currency reserves. Although government intervention can stabilize the exchange rate in the short term, it may have unintended consequences in the long run, such as inflation and reduced foreign investment. Therefore, it is crucial for the government to strike a balance between market forces and intervention to maintain a stable exchange rate.

The exchange rate of the dollar against the Pakistani rupee can have a significant impact on the country’s economy, affecting imports, exports, and the balance of trade. It is essential for businesses and individuals to understand the factors that affect the exchange rate and how to mitigate the risks associated with fluctuations in the exchange rate. A stable exchange rate is beneficial for the Pakistani economy, and it is essential for the government to adopt appropriate policies that balance market forces and intervention to achieve this stability. Understanding the exchange rate dynamics can help individuals and businesses to make informed decisions and mitigate the risks associated with exchange rate fluctuations.