Banking & Finance

SBP Governor’s strategy in hot water as foreign Investors pull out $1.6 billion hot money

SBP Governor’s take on hot money inflows to built country foreign exchange reserves has become hot issue for Governor itself. As foreign investors pullout $1.7 billion from Pakistan out of which $1.6 billion is from debt instruments and $106 million from equity markets. Foreign investors were enjoying higher returns in Pakistan due to record high policy rate of 13.25% maintained by SBP in order to meet IMF loan conditions.

Most of the hot money inflows came from UK and USA amounting to $2.3bn and $892mn. Due to recent novel coronavirus outbreak globalisation is under chaos as trade is slowing down, commodity prices are declining and equity and debt markets are melting down which has forced central banks to step in and reduce the policy rates on emergency basis. Foreign investors in Pakistan also following steps of their counterparts in the region and reducing their exposures in emerging market in order to reduce currency and country risk in their portfolio.

Over a multiple road-shows and investor conferences SBP governor has invited different investors to participate in Pakistan markets due to stability in currency post IMF bailout program and on-track reforms agenda under IMF program. Furthermore, in a recent meeting Dr Raza Baqir also said that Pakistan may not need an IMF program in future due to better reserve position by hot money inflows.

Moreover, SBP Governor while announcing last monetary policy also said the rising investment in T-bills reflects the improved confidence in the economy. So outflows means investors are losing confidence in Pakistan economy?

The term hot money flows is generally used for capital moving from one country to another in order to earn short-term profit on interest rate differentials or anticipated exchange rate shifts. These flows typically increase after a hike in interest rate in the host country. The interest rate differential between the rupee and the US dollar has increased substantially. Pakistan’s policy rate currently stands at 12.5%, which is 12.25 percentage points higher than the US policy rate of 0-0.25%.


Whether these inflows are bad?

“History says that these hot money flows are fairly temporary and make economies extremely vulnerable to external factors beyond the control of policymakers. These funds have distinct degrees of reversibility and have caused destabilisation in countries like Brazil, Thailand, Taiwan, South Korea and Indonesia. These flows are not only a source of vulnerability but have contributed to the most vicious two financial crises of recent times – the global financial crisis of 2007-08 and the Asian financial crisis of 1997.”

Some researchers have termed these flows highly speculative in nature. According to them, these flows create extreme instability in foreign exchange markets of host countries.

This means that these funds can fly out very quickly, creating selling pressure on local currencies and resulting in depreciation or devaluation. Impact of this can be seen in current exchange rate volatility in Pakistan in which rupee devalued from Rs154.24 to 158.57 in just one week.

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