November 26, 2001	Monday	Ramazan 10, 1422

HELPED by post-September 11 scenario and with the IMF on board, Pakistan is set to merge dollar surplus kerb and greenback deficit interbank markets on a priority basis and much sooner than targeted.

Indications are that commercial banks would be allowed to float foreign exchange companies (FECs) and money changers would be formalized into the FECs, allowing exporters and importers to transact freely with the FECs. Banks would be allowed to purchase dollars from exchange companies.

Foreign exchange companies would emerge as significant players in forex market with a single exchange rate. Importers and exporters would gain from the competition among a much larger number of exchange dealers, banks and FECs, operating in a enlarged unified market. Now, they have to negotiate the exchange rates with limited number of commercial banks in inter-bank market.

The merger of the markets is on the agenda of the IMF’s Poverty Reduction and Growth Facility arrangement expected to be approved by the Fund’s Board on December 5,2001, after which, the action plan for merger of exchange markets will be unfolded. Normally, the IMF sets target dates for various items of its programme.Implied is also the Fund’s support to the move for the three -year tenure of the PRGF.

And the expectation is that the cautious, step by step, approach on merger may be replaced by swift action, given the current favourable environment. The faster than expected liberalization of the foreign exchange regime, like banks being allowed to buy and sell foreign exchange without any commercial transaction, indicates the way things are moving.

Apparently, the State Bank task force entrusted with the formulating laws and procedures for setting up exchange companies and the amendments required in the Company Law, to empower the State Bank, to manage exchange companies, will be ready most probably before the end of next month. Initially,it was proposed to allow functioning of exchange companies from next fiscal year.

Currency experts are confident that any initial volatility in the unified exchange market, as witnessed elsewhere in the world,would be managed by a variety of factors. The cartel of 5-6 leading players in the kerb market would be tamed by international investigations into Hawala business with focus on Dubai that has narrowed the margins between the inter-bank and kerb markets. With the sense of fear among money changers and low premiums in kerb trading, it is time to merge the kerb and inter-bank markets.And they are optimistic that the policy makers would not miss the opportunity with the IMF on board and immense goodwill of the international community.

It is estimated that unregulated money changers cause an annual drainage of $7-8 billion. Even, if half of this amount is realized through official banking channels, the deficit in the current account would be turned into a surplus, allowing the country an exit from the debt trap and the IMF programmes. It is the lack of appropriate action to address the issue of Hawala business during 1980s and 1990s that gave the Hundi system ample time to mature. Thus the annual inflow of remittances dropped from $2.9 dollar in fiscal 1983 to the current level of just one billion dollars.

So far, various governments have focused on securing paltry sums of money from IFIs at the cost of stringent conditionalities and on appeasing exporters, neglecting the most obvious source of hard currency. They have ignored the fact a country’s trading patterns should be dictated by its comparative advantage. In case of Pakistan, it is clearly the export of labour that perhaps, earns more foreign exchange than the country’s textile exports. The State Bank is building forex reserves at unprecedented levels, now well over $4 billion. The IMF fiscal package and the increased bilateral assistance would help maintain reserves at comfortable levels for the State Bank to intervene and stabilise the market in times of fluctuations.As it is, with the kerb premium on dollar sales falling sharply, home remittances have picked up by 44 per cent in first four months of the current fiscal.

Foreign exchange reserves would also be sustained by the tied nature of the bilateral assistance that would stagger the pace of government spending.For example, the US grant of $600 million to provide fiscal and balance of payments support has been disbursed but the government is bound to seek the US approval of each item of expenditure.Normally, the entire rupee proceeds of donors’ assistance in foreign exchange are transferred to the government immediately after the amount is disbursed.

The lack of investment opportunities in a deepening recession in industrialised economies, the falling interest rates and the eroding of safe haven status of Hawalla business have set in motion a medium to long term reversal of flight of capital, preventing forex drain witnessed before September 11.

Currency experts are of the view that the State Bank would have to improve its risk management skills and should be given full autonomy to manage the exchange and interest rate policies. The IMF has already advised the government to prepare draft revision to the State Bank Act to guarantee autonomy to SBP to manage foreign exchange reserves and to ensure that the SBP governor and the SBP board members can be removed, as the Fund has put it “only by legal cause.”