THE State Bank of Pakistan (SBP)has successfully rebuilt foreign exchange reserves over the last three years. Much of this success, however, has been purchased by drawing liquidity directly out of the forex market. It attributes its purchases to improved market liquidity and describes their purpose as strengthening external buffers and the capacity to meet external obligations. These are legitimate considerations. Yet the extent to which dollars have been siphoned from the market to accumulate reserves raises concerns for the wider economy.

When the central bank becomes a persistent and dominant buyer of dollars in the market, it effectively crowds out some private businesses, which must compete with an institution that enjoys an informational advantage. While Pakistan is familiar with the crowding out of the private sector through large and persistent government borrowing to finance budget deficits, crowding out in the foreign exchange market is unprecedented.

If the forex market has sufficient depth, it can smoothly accommodate both the central bank’s purchases and the private sector’s requirements. But where the market is constrained, the adjustment has to take place somewhere. It may appear in the exchange rate,........

© Dawn