IMF Sets Premium Limit of 1.25% Between Open Market and Interbank Rates

Under the stand-by agreement (SBA) with the International Monetary Fund (IMF), the government will ensure that the average premium between the interbank and open market rate will be no more than 1.25 percent during any consecutive 5 business day period.

According to IMF’s Staff Report issued on Tuesday, the Pakistani authorities will ensure that no abnormal premium emerges in between the rate in any of the three FX markets—interbank, open, and informal.

The premium is defined as the difference in the natural logarithms of the midpoint (average of buying and selling rate) of the interbank market rate and the midpoint of the open market rate. For purposes of the continuous Structural Benchmarks (SB), the average is evaluated over a five-business day period.

The report noted that external pressures escalated in FY23H1 as foreign inflows came to a standstill and scheduled debt service drained reserves to critically low levels. Without the ability to formally intervene in the FX market, informal efforts began in the Fall, including moral suasion on banks, to nudge the exchange rate to appreciate.

When this did not succeed, import-payment restrictions and a crawl-like behavior from October 2022 through end-January 2023 fueled pressures in the FX interbank market, exacerbated the scarcity of dollars, allowed the FX black market to grow (with a rising informal premium), and caused disruptions in the timely import of key inputs for domestic production and exports.

It said that after reserves declined to about $3 billion in mid-January 2023, the exchange rate was allowed to depreciate by almost 10 percent on January 26. However, the normalization in the FX market was short-lived, with premia reemerging in February and again from May onwards on the back of import restrictions.

The Pakistani authorities have also committed that they will refrain from formal and informal guidance on the exchange rates of FX intermediaries and, after eliminating existing exchange restrictions and the multiple currency practice (MCP), will maintain a framework free of restrictions on payments and transfers for current international transactions and MCPs.

According to Topline CEO Mohammad Sohail, the 1.25% premium comes to around Rs. 4 to Rs. 4.2.

This essentially means that the gap between the open market and interbank rates cannot exceed Rs. 4.2, under the conditions set by the IMF.