Soon after the take-over as the Prime Minister of Pakistan in 1991, Nawaz Sharif undertook various types of reforms in the trade, banking and foreign exchange sectors.
In the foreign trade sector, these reforms, inter-alia, envisaged some liberalization by way of elimination of licencing system for imports and opening of import letters of credit by the banks on realising the import fee at the prescribed rate which at that time was 6 per cent. Later on the requirement of recovery of the import fee was also dispensed with.
In the private banking sector, small commercial banks were allowed to be opened. Apart from these small commercial banks, a few “investment banks” were allowed to be opened besides a large number of leasing companies and modarbas.
In the foreign exchange sector, a large number of liberalization measures were taken under the name of “exchange and payments reforms” which, inter-alia, envisaged (a) transfer of powers in the matter of release of foreign exchange for numerous purposes from the State Bank of Pakistan (SBP) to the banks authorized to deal in forign exchange called authorized dealers [ADs]; (b) allowing opening and maintaining of foreign currency accounts (FCAs) with the ADs in Pakistan by the resident Pakistanis including local firms and companies alongwith the non-resident Pakistanis and the foreigners; (c) open/free purchase/ sale of foreign currency notes and coins by the public from/to the parties other than ADs.
To facilitate free exchange of foreign exchange against Pakistan Rupee and vice versa, the SBP introduced a system of “authorised money changers” (AMCs) under which the AMCs were licenced by the SBP to undertake purchase/sale of foreign currency notes and coins and to purchase travellers cheques (TCs) at the exchange rate to be determined by the concerned AMC. The said facilitation gave birth to approximately 400 AMCs and a secondary foreign exchange market (kerb market) in addition to the normal inter-bank market. With the passage of time, the kerb market operators (AMCs) commenced to undertake parallel banking by arranging inward/outward remittances on behalf of their customers through the FCAs maintained by them with the ADs. It is widely believed that the foreign currency drafts for Haj under the “sponsorship” scheme are arranged by the intending pilgrims in Pakistan through these AMCs while the percentage of such drafts really sent by the relatives of the resident Pakistanis working abroad would be very low.
These money changers are also believed to be instrumental in arranging capital transfers from Pakistan by various sections of the population, through their FCAs in the legal manner without any apprehension of being caught. The consequence of the functioning of AMCs had been that the exchange rate of dollar (and other foreign currencies) in the kerb market was much higher than the inter-bank rate except on a few occasions when the kerb market and inter-bank rates became equal as has happened recently after September 11, 2001 events. Since the parties desiring to transfer money from Pakistan, which is neither permissible under the SBP regulations nor the transferers like to get the transactions documented, are always prepared to pay higher amount in Pakistan currency to the AMCs.
Naturally, the AMCs are to arrange purchases of dollar in the overseas markets for catering to the needs of the domestic transferrers of money for which they (AMCs), inter-alia, fall back upon the expatriate Pakistani workers wishing to remit money to their relatives living in Pakistan by providing quick and efficient on-door payment service and offering better exchange rates when compared to the inter-bank rates. For this purpose, the AMCs must have established their unofficial net-works abroad particularly in the middle-eastern countries. Other sources of the AMCs on supply side are the exporters who under-invoice the goods and sell a portion of the cost of their produce in the kerb market in order to get the benefit of the exchange rate. Thus with the passage of time, home remittances by the expatriate Pakistanis moved from official banking channels to the kerb market which may be comprising not only the AMCs but also the hawala/hundi operators. The SBP had in the past taken numerous measures to bring the home remittances under the official banking channel but did not succeed because the banks in no circumstances can compete with the kerb market operators in the matter of better exchange rates and prompt on-door delivery of money to the beneficiaries in Pakistan.
The policy of the present SBP governor has been to mobilise the smaller commercial/investment banks to merge among themselves. But there seems to have been no response to the SBP governor’s call as the majority shareholders (owners) of these small institutions would not like to do that because of the vested interest with which these banks and specially the investment banks were established by them. The SBP has, therefore, decided to ask these institutions to enhance the capital base from Rs500 million to one billion. Perhaps, the owners would increase the capital base instead of accepting the merger proposal.
The SBP governor has also floated the idea of creating foreign exchange companies (FECs) in Pakistan in order to ensure that home remittances by the expatriate Pakistanis are shifted from hundi/hawala market to the banks and the proposed FEC, and that all transactions are properly documented. The SBP governor also wants that the inter-bank market and the kerb market to be represented (or replaced) by the proposed FECs should undertake transaction at the unified exchange rates. The exchange rates to be quoted by the two sets of the financial institutions may differ but marginally as is the case in the inter-bank market but there should not be a wide gap between the two sets of rates as is the case at present.
The proposed scheme is believed to be put in place in the beginning of the next calendar year at the advice of the International Monetary Fund (IMF). The salient features of the scheme have not yet been made public by the SBP neither the legal framework for the operation of the FECs has so far been promulgated by the government. But the question is whether the proposed FECs will really be able to channelise the home remittance through them and the ADs and also whether FECs will be able to undertake transactions at the inter-bank market rates/ Let us examine the issue more academically.
The handling of bulk or substantial portion of the home remittances by the kerb market operators over the past several years reflect that they do have satisfactory (unofficial) arrangements in foreign countries for collection of foreign currencies from the remitters. At present, the foreign currencies collected abroad by these operators are either retained abroad or are placed in their FCAs maintained with the ADs in Pakistan. In the changed scenario, will the proposed FECs be allowed to open their branches in the foreign countries for collection of money, to open Nostro accounts with the banks abroad for handling such remittances and to invest the foreign exchange so collected by them in/outside Pakistan? Will the authorities in the concerned countries, particularly Saudi Arabia and other Arab countries, from where bulk of the remittances from Pakistani expatriates emanate allow the Pakistani FECs to open their branches for the purpose?
The chances of the Arab countries permitting the Pakistani FECs to open their branches there seem rather far-fetched because the exchange companies owned and operated by their own nationals are carrying on similar business by utilising the services and the net-work of the branches of the Pakistani ADs. The proposed FECs will, therefore, most probably be required to utilise the existing private and unofficial collection net-work abroad and in that event they will naturally be required to give better exchange rate to the remitters abroad in order to attract them. Consequently, it will not be possible for the proposed FECs in Pakistan to use the unified inter-bank/kerb market rate viz-a-viz the sale of foreign currencies to their customers. Another aspect of the matter is that so long as the demand from the (a) transferrers in Pakistan for transferring money from Pakistan, and (b) the SBP for purchases of dollar in billions from the kerb market persists, the kerb market operators will have the attraction of selling the foreign currency collected by them abroad at a much higher rate. Then why will they be undertaking transaction at the unified rate? The possibility of the proposed FECs conducting transactions at the unified rate can crop up only when the kerb market operators stand deprived of the purchasers intending transfer of funds from Pakistan to the foreign countries (and the SBP puts a halt on its purchases of dollar in bulk from the kerb market).
This can happen when the heavy capital transfers from Pakistan come to an end which is a remote eventuality. One can expect stoppage of illegal capital transfers through the kerb market in the event that the foreign banks do not remain safe havens for the owners of such funds. In the aftermath of September 11, 2001 events, the Western powers, whose banks hold bulk of the illegal funds transferred by the Pakistani politicians, corrupt bureaucrats, drug mafia men and smugglers, are contemplating to scrutinise all such accounts. If such a scrutiny is conducted across the board in the near future, it is likely to serve as a deterrent for the concerned transferers and lead the FECs to adopt the unified rate. However, in case the Western powers undertake the scrutiny on selective basis in accordance with their political imperatives, the situation is not likely to undergo substantial change in our country and flight of capital would continue thereby providing incentives to the kerb market operators to sell foreign exchange at the higher rates as compared to the inter-bank rates.
In view of the foregoing analysis, the chances of the proposed FECs conducting transactions at the inter-bank rates are not promising. The present scenario in which the kerb and inter-bank market rates have almost unified is the result of September 11, 2001 events which can fairly be judged as a temporary phase and is not expected to continue in the long run. The aim of documenting all inflows/outflows is also not likely to be achieved because a corrupt bureaucrat/smuggler/politician/mafia man seeking transfer of his ill-gotten wealth will never like to get his transaction documented. Even at present, the AMCs are not documenting their sales/purchases cent percent. The SBP has also failed to extract the details of their transactions. The large scale capital transfers had hitherto remained “underground” and status quo will continue even after the proposed FECs come into operation.