The bungle over retail dollar deposits

Published October 19, 2020
Enabling direct transfers of currency from exchange company to individual’s foreign currency account will minimise cash handling. — Reuters/File
Enabling direct transfers of currency from exchange company to individual’s foreign currency account will minimise cash handling. — Reuters/File

In the early hours of Oct 10, a statutory notification issued by the Ministry of Finance, titled Foreign Currency Account Rules 2020, started circulating on WhatsApp groups.

Clause 4 of the Rules stipulated that “any foreign currency account shall not be credited with any foreign exchange purchased from an authorised dealer, exchange company, or money changer, except allowed by the State Bank through general or special permission under any law”.

It simply meant that going forward it may not be possible to deposit foreign currency bought from an exchange company into foreign currency accounts.

It should be noted that as of Oct 5, deposits in foreign currency accounts amounted to more than $7.19 billion — or 37.2 per cent of total foreign exchange reserves of Pakistan — a portion of which was supporting foreign currency–denominated export and import refinance facilities.

Enabling direct transfers of foreign currency from the exchange company to the individual’s foreign currency account will minimise cash handling as well as the risk of money laundering

The Rules sent a signal that a deposit in such accounts has been categorically restricted (with some exceptions), implying that further tightening regarding the maintenance of foreign currency accounts and capital flows may be in the offing.

As panic gripped individual depositors, the central bank worked overtime. In the early hours of Sunday morning, it released a clarification saying there was no such restriction and individual depositors could continue depositing foreign currency as per usual practice.

An unintended consequence of the Rules could have been that individuals would start buying foreign currency from exchange companies to simply stash it away in lockers or under the mattress. This would have led to a gradual outflow of foreign currency from these accounts.

Another perverse incentive would have been the development of an informal market for foreign currency where those individuals who had foreign currency in their accounts could technically demand a higher price from those who wanted foreign currency to be transferred to their accounts. The creation of a shadow exchange rate would have led to more problems than the Rules tried to solve.

The spirit of the Rules seemed to be to discourage any potential hoarding of foreign currency. However, by restricting their deposit in a formal avenue, the Rules actually encouraged hoarding through perverse incentives.

It did shake up the confidence of individual depositors for a brief period. Rules should be drafted in a manner that they encourage a greater flow of foreign currency in the system

At a time when the country is seeking foreign currency from its retail expatriate base through Roshan Digital Accounts, such counterintuitive rules send a negative signal. This will not only discourage the flow of capital but also lead to a gradual withdrawal of retail foreign currency from the system.

Whether this was miscommunication or the message was lost in translation is anyone’s guess. But it did shake up the confidence of individual depositors for a brief period. Rules should be drafted in a manner that they encourage a greater flow of foreign currency in the system.

Know-your-customer and anti–money laundering regulations have already been tightened for customers, with foreign currency sold to individuals only against CNICs. Transactions exceeding a certain threshold are cleared by the central bank itself, which conducts its own due diligence.

Moreover, the current practice already entails that only tax filers can deposit cash in foreign currency accounts. With multiple layers of due diligence and cash deposits ring-fenced for only tax filers, restricting deposits through the new Rules would have meant overkill.

The process can be made more efficient by enabling a direct transfer of foreign currency from the exchange company to the individual’s foreign currency account. Similarly, the individual should also directly transfer funds in local currency to the exchange company. In this manner, cash handling will be minimised, and so will be the risk of money laundering, as funds will flow from one verified account to another.

Such a process will also reduce the security risk associated with such transactions as it involves cash withdrawals and deposits at multiple legs.

Rules and regulations are tricky. The right set of rules providing the right set of incentives can create a vibrant market and a high multiplier effect. Meanwhile, rules that give birth to perverse incentives and adverse unintended consequences can send a negative signal, stall growth and eventually result in market contraction.

Regulators and others going for regulatory overreach must also consider the ramifications of unintended consequences while formulating policy. The recent debacle is a classic case of how a lack of communication between the government and the central bank — or the inability to clearly communicate with people — could have led to the confusion and potential asset-liability mismatch at a micro level.

The writer is an economist.

ammar.habib@gmail.com

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