Engineered stability

PAKISTAN’S external account signals aren’t comforting. Export momentum is uneven, imports are rebounding and the current account has been oscillating between deficit and modest surplus. But the rupee has been unusually calm. That combination typically shows up as visible pressure on exchange rates in emerging markets. The missing puzzle piece is policy. The State Bank of Pakistan has been purchasing extensively from the exchange market over the past two years. Is the SBP merely smoothing volatility through interventions or actively shaping the market?

Currency market intervention isn’t necessarily controversial, and central banks do routinely step in to dampen disorderly swings, curb speculative overshooting and maintain market functioning. If transparent and proportionate, such action can lower uncertainty, support trade planning and anchor expectations. But there’s a difference between episodic smoothing and persistent purchases. When a central bank repeatedly becomes the dominant buyer in the market (a monopsony), it influences price discovery, even if it insists it’s not targeting a specific exchange rate. Over time, participants stop focusing only on trade flows, remittances and portfolio sentiment and begin pricing in its likely presence. The bank’s presence alone can dictate price formation.

When one player consistently absorbs supply, the exchange rate may stop reflecting underlying demand-supply fundamentals and, instead, begin to reflect administrative intent. As a monopsony, the central bank can dictate the dollar’s price. The result can be an exchange rate that appears stable but is actually managed at an artificially low level. The rupee has exhibited a degree of parity stability in the last couple of years. But while reassuring on the surface, it may not fully correspond to macroeconomic realities. If this process keeps the rupee stronger than what fundamentals would imply, the costs keep accumulating quietly before arriving loudly.

First, an artificially strong currency is effectively a subsidy to imports and a tax on exports. Imports become cheaper in rupee terms, while exporters lose pricing power in competitive global markets. For Pakistan, which is still constrained by limited export diversification and a structurally fragile external account, this weakens the one lever that can generate durable foreign exchange, trade competitiveness.

A credible exchange rate must balance three imperatives.

Second, an overvalued rupee distorts investment signals. Exchange rates aren’t only a macro indicator but are also economy-wide price signals that guide capital allocation. If firms and investors believe the rupee is policy — rather than fundamentals-driven, incentives shift. Tradable-sector firms hesitate to scale, import dependence becomes rational and domestic industry faces sustained pricing pressure from cheaper foreign goods. The long-run outcome is slower productivity growth and fewer jobs in sectors that can actually earn foreign exchange.

Third, credibility becomes the hidden balance sheet item. Once markets internalise the fact that the exchange rate is ‘guided’, expectations become path-dependent and traders ask what the central bank will tolerate rather than what fundamentals imply. Stability becomes brittle. In such a setting, a guided exchange rate ultimately proves costlier and more painful than market-based adjustment, as inevitable corrections arrive abruptly, triggering inflation, eroding real incomes and forcing emergency stabilisation.

To be clear, re­­serve accumulation itself is not a policy sin. Ade­quate buffers str­e­n­gthen sovere­i­­gn resilience, im­-

prove credit ratings and provide insu­r­ance agai­nst external shocks. But method and magnitude matter. If reserves rise primarily through sustained market dominance rather than through organic inflows, exports, remittances and FDI, the policy begins to resemble market engineering rather than market management.

A credible exchange rate framework must balance three imperatives: volatility management, price discovery and reserve adequacy. When intervention shifts from stabilisation to structural influence, the exchange rate stops performing its macroeconomic role as a shock absorber and instead becomes a policy variable.

The objective should not be a rupee that is politically comfortable, nor reserves accumulated at any cost. It should be a currency that reflects economic fundamentals while the central bank intervenes only to prevent disorderly conditions. Smoothing volatility is prudent. Sustained dominance is not. The distinction between the two determines whether policy strengthens the exchange market, or muddles it.

The writer is a freelance economist.

m.farooqarby@gmail.com

Published in Dawn, April 3rd, 2026

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