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Pak Central bank enforces tighter controls on open forex market

ISLAMABAD - The central bank has enforced tighter controls on open forex market and "informal" dollar outflows, particularly to the Gulf. Its a move fraught with far reaching consequences for overseas Pakistanis.

The tightening took place as the Pakistani currency continued to loose value against the dollar. The State Bank of Pakistan (SBP), the central bank, reported this week that the rupee may weaken further during fiscal 2005 that started July 1. The reason: "the external account deficit seem to be worsening." The trade deficit is projected to stay high in 2005. The government, at the same time is set to prepay some of its costly foreign credits, including $400 million in the first half of fiscal 2005. Some corportates also plan to prepay their foreign debts. It means while the dollar demand may sharpen, and supply, in the interbank and the kerb market, get even restrained because of the latest tightening.

However, the central bank said, "if the external account deficit worsens significantly, SBP may have to resort to reconsidering its exchange rate stance accordingly. But, even in that case, any necessary adjustments are expected to be gradual."

The tighter controls follow the Greenback's continuous rise against the rupee. In order to stem the tide, SBP disclosed, for the first time, that it has been selling dollars in the open market since April this year, but the rupee continues to dip.

However, SBP did not indicate the volume or the level of dollar injection into the market. The other major objective was to "curb the premium" between the interbank and the kerb rates as the later market is fed by 'hawala' or 'hundi' transactions, and informal inflows and outflows. The fall of the rupee was particularly visible during April-June. Overall, the rupee lost Rs. 0.31 or around 0.5 per cent of value against the greeback during fiscal 2004, that ended June 30. In this period, it declined from Rs57.81 to a dollar June 30, 2003 to Rs58.12 exactly a year later on June 30, 2004, in the interbank market. The interbank rate over the weekend was Rs58.23/58.03. It was 58.55/58.40 in the open market against the dollar. "The greenback seems to be moving up," foreign bankers said.

But, SBP's biggest worry is the visible, and growing, switch of home remittances from the regular banking chanels to 'hawala' or 'hundi. Transactions in these modes feeds the open currency market, whereby it goes out of the government's reach, and into an unkown tax-free world of smuggling, drugs and what have you. The spread - Rs0.40 to Rs0.55 to a dollar - between the two markets, has been increasing over recent weeks.

SBP also attributes the uptrend of the dollar in the kerb and higher premium it is offering to what it calls "a tactic used by SPB-license holding Authorised Money Changers (AMCs) to force the central bank to allow them to continue their business in its present form." SBP had ordered 378 AMCs across Pakistan to cease business June 30. It had offered them to convert themselves either into Exchange Companies (Ecs) or "B" Category Exchange Companies (BECs), or to become franchisees of ECs. SPB will allow BECs only to buy or sell foreign currency notes or coins - but not to transmit money abroad in any form. The AMCs have been resisting these moves in order to maintain a free hand in all incoming and outgoing transactions.

But the end of AMC's came June 30.The SBP directed them to fully comply with the new money changing, forex transfer and receipt regulations.

That means documentation and reporting forex transactions to SPB -something money changers, and each one of their customers - hate.

"A small percentage of AMCs have indicated their intention to exit the money changing business altogether, a statement by SBP said July 1. Only 28 AMCs remain undecided, resulting in the lapse of their license to transact money changing business. They can seek franchise from authorised Exchange Companies (Ecs)," already established under SBP authorisation.

SBP says, "with the successful completion of this phase of bringing forex exchange business under corporate discipline a vast majority of such transactions will now come under proper documentation." "It will also be subject to the internationally accepted norms of Know Your Customer (KYC) policy, identification and detection of suspicious transactions and it will provide support to the efforts against money laundering." Effective July 1, 2004, all money changing business will be transacted, in addition to banks, through Ecs only. All AMCs who were earlier authorized to transact exchange business under licence from the SBP have ceased to function from the close of business June 30,2004. SBP will, now, ask law enforcement agencies to stop business of illegal money changers.

In terms of business volume, documentation of funds, all transactions and customers, will particularly impact open market, 'hawala' and 'hundi' operations between United Arab Emirates and Pakistan. What is the rationale behind it? A senior central banker says, "we hope documentation will constrain the informal money markets of Pakistan. The UAE is the key hub for informal markets of Pakistan as there is a direct link between home remittances sent by overseas Pakistanis from UAE and the kerb market premium."

What has fuelled the latest demand for greenbacks? SBP says bullion dealers and gold merchants have created a large demand for dollars to import gold from the Gulf. Bullion buying from the Gulf has been going on for years. The demand for gold rises in early summer. Soon after the big wheat crop is harvested, the farmers have cash in their hands and that's the wedding season.

It spurs demand for gold in India and Pakistan - the biggest consumers and buyers of this metal in the world. But, this time, the demand for dollars rose also because the government prepaid to Manila-based Asian Development Bank $1.17 billion expensive credits, the multinationals and corporates had to transmit annual dividends and profits. The trade gap also widened, imports rose rapidly to $13,7 billion or 24 per cent over fiscal 2003. Export also rose, but slowly, to $11.1 billion or 11.8 per cent, widening the trade gap 128.2 per cent to $2.7 billion. Above all, a number of overseas Pakistanis switched back their home remittances from the official banking chanels to 'hawala' or 'hundi' to cash on the growing premium in the kerb as against the interbank rate.

Inflows in the current fiscal 2004 have declined compared to 2003, adversely affecting the supply. Home remittances from overseas Pakistanis declined from $4.06 billion to $3.80 billion. A widening trade deficit caused by higher prices of imported oil and larger machinery imports. There were higher outflows as payment of services including travel and shipping. US logistics support to Islamabad for anti-terrorist campaign declined. The Saudi Oil Facility (SOF), partly on deferred payment basis, stopped. The capital account posted a sharp reversal from, a surplus of $ 98 million in the third quarter of fiscal 2003 to a deficit of $547 million in the same quarter of 2004. The trade deficit widened because of an import surge, driven by import of machinery and capital goods as the economy picked up, and many industries upgraded, expanded or created new production capacity. Pakistan can foot the bills for all its imports to feed the present pick up of the economy, with its official forex reserves are at an all-time high of $12.5 billion.

The reserves cover 51 weeks of imports. That is a good news for foreign businesses that export capital goods, machinery, industrial raw materials and consumer durables to Pakistan.

Will the demise of money changers mean and end to 'hawala' or 'hundi'? Will the kerb turn into: a grey, or a black market? Can SBP really stem the rupee dipping further?

Who will win - SBP's grey eminence or currency operators' guile and ingenuity? Thorny questions! The new fiscal 2005 alone has the answers.