Pakistan's economy is entering a new era of opportunities and threats. Sustained economic growth, controlled inflation, increased foreign reserves and dynamic outlook have been the hallmark in the last 4-5 years.
The economy has recovered and is moving in the direction envisaged by economic managers.
Economy is buoyant and expanding; evidence of growth is being observed in all sectors. Stock market capitalization has touched $27.53 billion and exports and imports are up as compared to the last quarter. However, there are indications of a slight shift in the capital movement and dollarization of the economy, bringing back the memories of the early 1990's.
Dollarization is taking place slowly but surely if one was to take into account the continuous rupee slide against the dollar. Rupee has depreciated 2.57 per cent against the dollar in the kerb market in the 31 days of the new fiscal year. It is sliding down while dollar is moving up, encouraging people to open dollar accounts in banks.
As the kerb rates are looking up overseas Pakistanis and locals and investors have started opening dollar accounts in banks. Rate of dollar accounts opened in FE-25 (the last circular of the SBP on dollar deposits) has increased by 21 per cent as compared to the month of July. Moreover, the use of hawala/hundi is on the rise again, making the capital movement far more quicker than before.
With real estate as an alternative investment option, people are purchasing more and more property in the Gulf, the UK and the USA. Rate of remittance from abroad has gone down, fuelling speculation of a sort of East Asian type.
If we analyze the situation, there are several indicators which would buttress the argument. There has been lot of pressure on the rupee with continuous fall and mad purchase of dollar in the kerb by currency market players.
In the last two months, we have seen a decline of $485 million from the liquid reserves of the country which stood at $12.17 billion now. The rupee was already under pressure in July as $2.32 billion were paid on account of foreign currency debt servicing,
Interest on loan amount, settlement of oil and petroleum companies took the major share of those payments, with interest rate scenario and importers hedging to a gradual increase in the forward premium, though they are trading slightly below differential.
The SBP has been very active and has admonished the currency players not to resort to dollarization of the economy. The SBP has sold $797 million in the market to keep the rupee stable both in the inter-bank and kerb market in the last 45 days. It sold $25 million on 4th August and made several interventions in the market to stop the downside. Our importers are unnecessarily rushing to banks to open L/C.
Lately, Indian rupee has also weakened against the US dollar pushing Pakistani exporters to keep on their toes in the international markets. But it does not mean that importers go berserk for the dollars overnight.
Another indicator of bullish sentiments for dollars is the fact that foreign currency deposits are now up by 21 per cent as investors are buying dollars to take advantage of the increased interest rate of 1.25 per cent by Fed. These deposits are known as FE-25, because they are regulated and monitored by the Foreign Exchange circular 25 of the SBP.
Remittances touched $4.1 billion in the last fiscal year 2003-2004. The current financial year saw that expatriates are making increasing use of hawala and hundi as the rupee-dollar parity widens in kerb and inter-bank market.
Surging imports, and widening balance of payments deficit have created demand of dollars over the last two months. As dollar in the inter-bank and kerb market rose against the rupee, the premium in the kerb also increased.
It is inducing many Overseas Pakistanis to switch back to hawala instead of going through official channels. The SBP is closely monitoring the kerb and inter-bank markets to ensure larger and clean inflow through banking channels.
The SBP has enforced strict anti-money laundering regulations whereby banks have to comply to report to any suspicious activity of an account holder. This has created a fear among the Overseas Pakistanis from sending remittances back home not only to their accounts but also to their relative accounts as well.
Capital fight is also being witnessed for the first time. Perhaps the country is heading for a new odyssey in the financial freedom of the global market. With liberalization, deregulation and privatization now the buzzwords, capital flight is happening at a faster pace. Despite the investment-friendly budget, the direction of economy will be guided by the political changes at the top, if any.
It is estimated that an amount of $143 million has made an easy exodus from the economy in the form of capital flight in the month of July-2004 alone. The amount looks pretty small but it will add up to a bigger amount in the near future.
Many people wonder how this can happen in our country. To support this claim, there are three evidences that make it inevitable that ongoing capital flight is taking place which seems very vulnerable in coming weeks and months.
First, exchange rate had been adjusted not officially but with laissez-faire policy of the SBP saw the rupee sliding down rapidly. It appeared to be a part of the macro level strategy to let the rupee fall against dollar to assist exporters stay competitive in the global market place. It was evident from the fact the exchange rate was under pressure as investors are moving funds out of Pakistan.
Another factor that has pushed the exchange rate in the alignment position with the SBP is the stock market that has touched a record 5620 points with total market capitalization reaching $27.53 billion.
However, our stock market is over-valued and is actually priced at $17.29 billion. A total of $473 million has left the market-place after the attack on Finance Minister Shaukat Aziz, according to an analyst at the Karachi Stock Exchange.
They say that stock market is the true barometer of the country's, economic health. However, our stock market is very small, speculative and fragile. According to a leading brokerage house everyone was playing on the short-term basis; selling at the rise and buying at the dips in the absence of any negative or positive reports in the market.
Many leading brokers apprehend the future share business outlook may not be that as the promising as the perception of political instability and terror attack could be more harmful than any other single bearish actor.
Added to this are other elements. Capital flight particularly to Dubai, the UK and the USA where new residential housing is being offered to the overseas investors. It is estimated that overseas Pakistanis hold about $87 billion in saving in different banks.
Pakistanis are purchasing housing and commercial property in Dubai and Bahrain, thus greater fall in the rupee's value as a result of this housing craze among the Pakistanis.
Property prices are shooting up, whereby enticing people to make quick money in a very short period of time. This is creating problems for the economy as funds are being moved from banks for purchase of dollar for remitting abroad.
Globally, property prices are going up, fuelling asset price inflation at a very rapid pace. Real estate has emerged as a lucrative investment option for investors, almost globally with the demand for property going up adding hyperinflation in asset prices.
Finally, the fragile economic position, the balance of payment looks under lot of pressure to bear the ongoing capital flight brunt, which is not easy to sustain. Higher oil prices has placed insurmountable challenges to economic managers to provide a relief to the balance of payment position.
This can be judged recently when $ 100 million foreign loan prepayment to a Japanese company was to be made by the PARCO. The SBP got the prepayment postponed for three months by rolling-over the loan in order to reduce the rush for dollars. This run-on dollar is very precarious for the economy and the SBP needs to keep a close eye on the forex market of the country.
This clearly illustrates the fragility of the rupee and the forex system. The degree of damage that speculators, forex companies can cause to the rupee-dollar parity could be devastating for the economy.
However, it could have been avoided by imposing Remittance Value Tax [RVT]. The concept is very simple and has worked very successfully in countries like Chile and Brazil. When you make payment through remittance to your principal abroad, you have to pay certain RVT on the amount to the central bank.
Chile imposed RVT when the region was in trouble and going through turmoil in 1998 and worked remarkably well thus controlling the flight of capital. It did not suffer any foreign direct investment in the country after imposing this law and capital flight did not occur during the time.
Pakistan can also introduce RVT in order to control capital flight and thus saving the economy from speculators and currency market players who created similar havoc in the Asian Financial Crisis in 1997-1998.
The SBP needs to dictate the market so that speculators and hoarder are under tight check. The significant thing is that the SBP is vigilant constantly monitoring the situation and continues to manage the volatility in exchange rates and does not allow the speculators to put undue pressure on the rupee.
The SBP had stated in its monetary policy statement for July-December, issued on 21st July, that it would monitor the interest rate and exchange rate situation in the coming months.
Interest rates are projected to rise gradually in response to change in liquidity position, rise in interest rates in the international financial markets and inflationary expectations but their potential adverse impact on investment and growth will have to be minimized through better monetary and exchange rate management.
The SBP needs to handle this precarious situation in a very succinct and delicate manner so that it does not alienate the investors and public in general. The investor friendly climate should continue, to flourish and at the same time exchange rate mechanism should be carefully monitored and regulated under market-driven policies.
The deficit in balance of payments should be brought under control so that it does not exert pressure on the rupee-dollar parity in order to contain the outflow of capital from the country.
The rupee in the near future is likely to fall further against dollar and other major currencies because of a mismatch in supply and demand. Capital flight and dollarization of the economy could prove costly for Pakistan if the fall in the value of the rupee is not checked soon.
