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Averting default

Pakistan currently faces many economic challenges with the lingering threat of default being the most potent one. By way of explanation, a country defaults when it is unable to repay its creditors.

While discussing the economic state of Pakistan, experts mostly focus on long-term reforms with no practical proposals to avert default. The good news for Pakistan is that its current resources and foreign reserves – if channelized properly – are sufficient to fulfil its debt obligations and cover its import requirements.

Pakistan, a country of around 220 million people, has a huge population of young people; 60 per cent of its total population is below the age of 29. Pakistan’s annual IT and ITeS (Information Technology enabled Services) exports are nearly $2 billion; India’s IT exports are more than $150 billion. However, many believe that the official figure is far less than Pakistan’s actual IT exports of $9-10 billion.

Experts think that nearly 75 per cent of Pakistan’s IT and ITeS export proceeds are neither brought in the banks of Pakistan nor reported in official records of state institutions. These undocumented export receipts are parked outside Pakistan. This happens because Pakistan’s policies are not conducive for the free flow of foreign funds.

Other reasons include the accelerated devaluation of Pakistan’s currency – it hovered around 35 per cent last year – which renders tax benefits extended to IT exporters useless. Also, the ever-increasing gap between interbank and market rates make exporters wary of bringing funds in the country. The country provides no socio-economic benefits to exporters for bringing export receipts to Pakistani entities. Exporters also do not want to deal with high subscription costs in the backdrop of excessive banking charges.

Bangladesh’s emerging economy also faced these problems, and the country’s finance ministry took a number of steps to allow the flow of export proceeds and remittances into the country. It announced a 2.5 per cent cash incentive on foreign remittances in 2022, up from previously 0.5 per cent. Cash incentives practically meant that for every foreign currency remittance, the government would pay 2.5 per cent on top of the value of the remittance in the local currency ‘taka’ to the beneficiary.

This step was taken for two reasons: first, it removed the burden of increased expenses incurred while sending remittances; and second, it encouraged people to send remittances through legal channels. Bangladesh reported a 36 per cent increase in such remittances after the adoption of the cash-incentive policy.

Estimates suggest that at least 40 per cent of Pakistan’s remittances are sent through informal channels called hawala/hundi. Unfortunately, there is a huge gap between the interbank and open market rates in Pakistan; in the last few months, it increased to Rs20-50 per US dollar. The gap has narrowed recently due to the liberation of the bank rate. Pakistani banks are profiting off of the uncertain market conditions. The State Bank of Pakistan needs to set up separate desks for remittances instead of relying on commercial banks.

For the year 2023, remittances are projected to be around $27-28 billion. The figure could be 40 per cent more than the budgeted rates if we follow the Bangladeshi policy of announcing a three per cent cash incentive and reducing the gap between the interbank and market rates. This can translate into additional $10 billion annual remittances from overseas Pakistanis.

In 2022, several media outlets confirmed that former prime minister Imran Khan had approved an incentive programme for IT exporters which aimed at increasing export receipts. The programme announced a tax holiday for IT companies and freelancers along with 100 per cent forex retention. It planned to establish special technology zones on a fast track basis by declaring CDA sectors as STZs. Another feature of the programme was the launch of Roshan digital accounts to allow freelancers and IT firms to retain 100 per cent of their foreign income in foreign exchange.

Incentives like no restrictions on outward remittances from foreign currency accounts for Pakistan Software Export Board-registered companies/entities and steps like the resolution of double taxation of the IT sector and exemption from capital gains tax for venture capital funds investing in startups could have gone a long way in strengthening the country’s IT sector. But the government of Imran Khan faced a vote of no-confidence soon after announcing the incentive package and eventually lost power in April 2022. As a result, the policy couldn’t be approved.

Had this policy been approved, the foreign currency proceeds from the IT sector alone would have escalated to nearly $10 billion. The incumbent government can enact this policy with an additional clause of a cash-incentive programme of 3.0 per cent. This effort will immediately encourage IT companies to bring their total foreign currency earnings to Pakistan, which will result in an additional $8 billion annual receipts.

The cash margin incentive scheme of 3.0 per cent for foreign remittances by overseas Pakistanis and conventional exporters will attract 40 per cent additional receipts, totalling to nearly $ 22.8 billion. This coupled with $8 billion receipts raised through the incentive programme can increase the foreign exchange receipts by $30.8 billion. The additional foreign exchange receipts of $30.8 billion on top of the total present foreign receipts of $59 billion ($27 billion remittances from overseas Pakistanis and $32 billion exports) will aggregate to $89.8 billion, which is sufficient to cover both the present annual debt and the import bill, subsiding fear of imminent default.

Beside these measures, Pakistan should adopt some medium- and long-term plans to improve the social and economic situation of the country on a sustainable basis. Pakistan does not necessarily have to re-invent the wheel; it can replicate the success story of Bangladesh’s cash incentive scheme with an incentive programme for IT companies to immediately avert default.

Pakistan may require an additional annual budget of nearly Rs700 billion to cover the cash incentive program which can be generated by re-allocating funds from certain politically motivated subsidy schemes. The government can also raise the funds through deficit financing. The expense will be worth the reward.

The steep fall of foreign currency reserves to a dangerously low level is causing serious damage to all sectors of the economy including large-scale manufacturing. Several auto manufacturers have shut down their plants for an extended period due to their inability to import the raw material required to run their units. The depletion of foreign currency reserves means the scaling down of economic activity, soaring inflation and high unemployment.

Pakistan fortunately has the potential to avert the imminent crisis if the right policy measures are adopted on a war footing.

Pakistan does not necessarily have to knock on the doors of the IMF and other lenders for a meagre amount of $1 billion every now and then. We can do much better than that on our own.

Awais Anwer Khawaja, "Averting default," The News. 2023-05-01.
Keywords: Economics , Economic activity , Economic challenges , Remittances , Export , Imran Khan , Pakistan , IMF