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, transaction spreads, delays in opening letters of credit (LCs), or restrictions on access to foreign currency. In effect, private sector buyers are either priced out of the market or pushed into waiting queues.
There have been several media reports of import payment delays and dollar rationing by some banks. Concerns about these practices have also surfaced in official trade assessments. The US National Trade Estimate Report 2026, for instance, records stakeholder concerns about delays in banks’ issuance of LCs, reportedly resulting from informal SBP limitations on commercial banks’ borrowing of foreign currency through the interbank market. The report also highlights that corporations and foreign equity holders have encountered administrative delays, documentation hurdles, and informal queuing systems when seeking to repatriate their profits, dividends, and royalties in dollars.
The SBP must reassess its market interventions.
Such restrictions carry consequences. Central banking, in essence, is not an accounting exercise and balance sheet management. Every action has microeconomic and macroeconomic repercussions for resource allocation, business costs, investment decisions, and, ultimately, economic growth. Thus, a policy intended to strengthen the country’s external position can, paradoxically, undermine investors’ sentiments and the productive capacity to generate future foreign exchange.
A further paradox concerns the exchange rate signal. Despite extensive purchases, the exchange rate is not responding. Conventional macroeconomic models offer limited help in explaining such interventions. Instead, an exchange rate microstructure approach, built on order flow, may offer a better explanation of exchange rate determination. Order flow refers to the buying and selling pressure generated by market participants. This approach recognises the importance of participants’ identities, information and trading behaviour in influencing exchange rate movements. A study by Evans and Lyons, published in the Journal of Political Economy in 2002, shows that order flow has substantial explanatory power for exchange rate changes.
When a central bank, which also issues licences to the market participants, enters the market, its order flow may convey its preferences about price as well as quantity. Forex dealers, observing this institutional order flow, may adjust their quotes and inventory positions accordingly. Consequently, the exchange rate may increasingly reflect the central bank’s institutional preferences rather than the underlying balance of forex demand and supply.
Granular level data can explain forex dynamics on the basis of the order flow model. The SBP has both the technical capacity and the high-frequency data required for such analysis. It could examine import payment delays, outstanding foreign exchange requests, transaction spreads, interbank turnover, and the daily pattern of its own purchases. A range of forex market data is already covered by IMF monitoring and reporting requirements on a daily basis. Greater transparency and wider dissemination of this data may also allow independent researchers to apply an order flow model to exchange rate formation in Pakistan.
Reserve accumulation is a necessary but not sufficient condition for stability, which ultimately depends on the economy’s ability to generate foreign exchange through exports, investment, and productive activity. The SBP must, therefore, assess its market interventions within a robust analytical framework and develop an exit strategy for its dollar purchases for reserve accumulation.
The writer is an economist.
Published in Dawn, November 12th, 2026
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