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Eccentric currency market reforms

September 2023 holds some significant importance for Pakistan, marked by a series of notable events. In the first week of this month, we witnessed unusual and rapid surge in the dollar rate, leading to historic depreciation of Pak rupee and then some recovery in interbank and open market. On September 9, 2023, President Dr. Arif Alvi completed his five-year term—though he will continue until a successor is elected after the upcoming general elections, as envisaged in Article 44 of the Constitution. Another notable event is going to take place on September 17, 2023 when the new (29th) Chief Justice of Pakistan will take oath of his office.

In the political arena, the former Prime Minister Imran Khan is in Attock Jail under judicial remand after suspension of sentence in the Toshakhana case. He is incarcerated for allegedly leaking state secrets in cipher case. In another development, Shehbaz Sharif, President of Pakistan Muslim League Nawaz (PMLN), has announced the return of convicted ex-primer Nawaz Sharif on October 21, 2023. Lahore high Court had allowed him to proceed to London for medical treatment for four weeks in November 2019.

In the coming days, Pakistan is poised to experience developments on both the political and judicial fronts. The accountability court’s sentence and subsequent declaration of absconder pose challenges to Nawaz Sharif’s return. However, it seems likely that he would get protective bail, and eventually be exonerated due to a weak judgment and the late judge’s admission in a recorded video that he was blackmailed into convicting the three-time ex-prime minister. As regards chief of Pakistan Tehreek-e-Insaf, he is facing charges in multiple cases. Although he has already obtained interim relief in the Toshakhana case, his alleged involvement in the cases of cipher, Al-Qadir Trust, and the events of May 9, 2023 can prevent early release.

While the days ahead will be vital to determine political direction of the country, Pakistanis are fervently looking for much-needed relief from the harsh economic conditions that our elected representatives have miserably failed to address in the last six years. Pakistan is currently facing the pressing issue of volatility in currency market where the Rupee has depreciated by nearly 200% against U.S. dollar since 2017 that has apparently stemmed from an imbalance between dollar inflows and outflows.

Although economic managers of the alliance government of Pakistan Democratic Movement (PDM) made herculean efforts in financial year (FY) 2023 to contain current account deficit to a manageable level, to consistently meet foreign debt obligations, Pak Rupee continued to decline. This proves that our policymakers have failed to effectively tackle underlying factors affecting value of Rupee, leading to significant disparity between inter-bank and open market exchange rates for US dollar and other foreign currencies. The root cause can be traced back to outmoded and ineffective administrative structure and border control measures. According to a February 2023 Bloomberg report, traders and smugglers illicitly transport up to US$5 million across the border into Afghanistan daily, amounting to approximately US$ 1.8 billion annually. At the same time, goods are also smuggled from and to neighbouring countries.

Why have our law enforcement agencies failed to effectively enforce regulations governing unofficial channels used for cross-border currency and goods transportation/smuggling? Despite our commitment to align with the global standards set by Financial Action Task Force (FATF), which include its 40 recommendations aimed at combating unlawful movement of cash, the performance of law enforcement agencies is clearly lacking in terms of effectiveness of measures taken to implement Anti-Money Laundering and Counter Financing of Terrorism (AML-CFT) regime.

FATF Recommendation 32 addresses regulation of cash couriers, and mandates that countries should establish measures for detecting physical cross-border movement of currency and bearer negotiable instruments. These also include declaration/disclosure systems. Additionally, the recommendation emphasizes the importance of having effective, proportionate, and deterrent sanctions in place for individuals who make false declarations/disclosures. Furthermore, in cases where bearer negotiable instruments are linked to terrorist financing or predicate offenses, countries are required to implement measures, including legislative actions in line with Recommendation 4, to facilitate confiscation of such currency or instruments.

Despite being on FATF’s enhanced monitoring list known as ‘Jurisdictions under Increased Monitoring’ for more than four years due to its weak AML-CFT regime, Pakistan has fallen short of full compliance with these two recommendations aimed at curbing illicit cash movements and smuggling. Even after removal from grey list, a recent report presented in the Prime Minister’s office sheds light on some concerning findings regarding informal currency transportation system. The report reveals that 722 currency dealers in Pakistan are involved in hawala/hundi business, with 205 of them located in Punjab, 183 in Khyber Pakhtunkhwa, 176 in Sindh, and 104, 37, and 17 operating in informal capacities in Baluchistan, Azad Jammu & Kashmir, and Islamabad, respectively.

Weak regulatory control and a relaxed monitoring system have contributed to devaluation of Pak Rupee against US dollar, with exchange rates surpassing Rs. 330 in the open market at one point of time. Furthermore, the primary driver behind the growing grey and black markets is the illicit movement and smuggling of goods.

Transactions, which are not processed through official channels due to embargoes, restrictions, or delayed bank payments, are settled using dollars acquired from the open market. However, delay in addressing these issues has not only led to inflation within the country but has also caused shortage of essential products, causing huge losses to the national exchequer. The scale of smuggled goods is a cause for concern, as reported in the media that Customs officials seized essential goods worth US$73.2 million in a nationwide crackdown on smuggling.

Media reports have unveiled a disturbing pattern of smuggling involving sugar and urea out of country, while petroleum products are unlawfully entering Pakistan from Afghanistan and Iran. Media reports also indicate that approximately 2.810 billion liters of oil is smuggled from Iran to Pakistan annually, resulting in an estimated annual loss of 60 billion rupees to the national treasury and alarmingly, which is believed to be used by terrorists to fund their illicit activities.

The reports further highlight involvement of 76 dealers in border-adjacent areas engaged in smuggling. Additionally, it is disclosed that 995 petrol pumps across the country are selling Iranian oil. The reports implicate 90 government officials and 29 politicians in oil smuggling.

As gap between inter-bank and open market rates exceeded the agreed-upon ratio of 1.25% with the International Monetary Fund (IMF) and increasing inter-bank rate to match open market rate seemed inadvisable, law enforcement agencies intervened and launched a crackdown on illegal currency markets. This led to the closure of various currency dealers across the country that consequently, resulted in rupee rate falling below Rs 300 (lower than inter-bank rate) in the open market. This ad-hoc measure to bring down dollar rate regardless of consequences is being appreciated by various segments of society.

In the wake of crackdown, the State Bank of Pakistan (SBP) implemented reforms in the Exchange Companies sector by raising their minimum capital requirement from Rs. 200 million to Rs. 500 million for new companies. SBP has also provided category B with possibility to transition to exchange companies on the condition that they satisfy regulatory requirements within three months; otherwise, their licenses could be canceled. Furthermore, these companies are given the choice to either merge with or sell their operations to corresponding franchiser company within three months, provided they fulfill all regulatory prerequisites. They are required to submit their conversion plan within one month to obtain the necessary no-objection certificate (NOC).

On the contrary, no action has yet been taken by SBP against eight commercial banks implicated in currency manipulation. Admittedly, they were charging their customers open market rates or even more for foreign currency transactions instead of interbank rates. It is quite ironic that before the massive crackdown these commercial banks were found guilty of not settling credit cards’ foreign transactions at interbank rates despite SBP’s notification to this effect.

It is a fundamental principle that every country facilitates its businesses so that they can contribute to economic growth. In Pakistan, however, instead of fostering coordination among agencies and regulators and implementing an effective control system to regulate them without disrupting business operations, our policymakers tend to complicate matters or set excessively high standards which small-scale business owners struggle to meet. A similar approach has been adopted by SBP in its efforts to streamline operations of exchange companies.

While the recent actions taken against those involved in currency manipulations are commendable, they also prompt us to question why we did not implement a robust monitoring system earlier, instead of waiting until the US dollar rate surpassed Rs 330 in the open market. Cognizant of the fact that porous borders cause significant revenue losses, our agencies remained passive, allowing the country’s economy to decline. Furthermore, despite being aware of public officials’ involvement in facilitating currency and product smuggling, no action has ever been taken against them.

While these actions highlight our insufficient control enabling growth of the informal money remittance system, bringing bad repute to our country, stringent measures implemented by agencies and SBP are adversely affecting small-scale businesses, leading to their elimination. The only viable path to streamline the system is by fostering effective coordination among agencies, establishing a comprehensive control environment, and ensuring its efficient monitoring. Setting rigorous standards for conducting businesses in the name of reforms, to eliminate small-scale businesses will yield no benefits but will rather exacerbate unemployment.

Huzaima Bukhari, Dr Ikramul Haq and Abdul Rauf Shakoori, "Eccentric currency market reforms," Business recorder. 2023-09-15.
Keywords: Economics , Monterey fund , Economic growth , State Bank , Economy , Toshakhana , Dr. Arif Alvi , Shehbaz Sharif , Imran Khan , Pakistan , IMF , PDM , PMLN , SBP

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