The rupee remains under pressure although the State Bank now provides foreign exchange for Pakistan’s oil imports. Bankers give many explanations for the rupee’s weakening, the oddest being the drying up of foreign investment inflows.

Prudence demands that imports be funded by export proceeds and inward remittances. Foreign investment should primarily fund fixed capital formation, not consumption.

This flawed culture of import financing has pushed trade deficit to $20.75 billion in FY07-08 from a paltry $2.9 in FY03-04. Courtesy rising imports, that must be paid for while exports proceeds remain stranded on their way to Pakistan (largely due exporters’ greed for benefiting from the continuing fall of the rupee), the current account deficit is ballooning.

Foreign investment will remain subdued until the dust settles on political front. Proof thereof is that even the two-year deferred payment facility for oil import, reportedly promised by Saudi Arabia, has not been activated and oil imports continue to deplete foreign exchange reserves. Support from China too has been restricted to $0.5 billion. What worsens this scenario is the continuing flight of capital to the Gulf States.

This trend is reviving the chances of borrowing from the IMF on paralytic terms, to support dwindling balance of payments. As it is, by June 2007, Pakistan’s external debt had risen to $40.1 billion. But Moody and S&P felt that external debt (then 26.5 per cent of GNP) justified upgrading the rating of local and foreign currency bonds to B1 from B2, to encourage fresh debt inflows.

The catch was that 62.5 per cent of the inflows in 2006-07 were priced on floating rates of interest. In its 2006-07 Annual Report, SBP had pointed to the associated risk of higher debt servicing cost because a global rise in inflation could trigger a hike in the LIBOR. The prediction was right; debt-servicing cost has gone up and Moody and S&P have revised credit rating back to its lower 2006-07 level.

The external debt is denominated in several currencies, mainly dollar, euro, pound, and yen, and the payable amounts must be bought against sale of dollars. In dollar terms, the debt is now $45 billion. Of the $5 billion rise over its 2006-07 level, about $1 billion represents actual inflow and the rest the impact of dollar’s depreciation against the currencies in which the debt is denominated.

With the rupee depreciating at an average of three per cent a month since January 2008, the outstanding external debt and the impact of servicing it (in rupees) will have grave implications for the fiscal deficit and public expenditure. The reported 40 per cent cut in PSDP is the first sign thereof. Hopefully, it won’t force abandoning projects that could bolster the eroding competitiveness of the industrial sector.

Currency-wise break-up of external liabilities is not available; official disclosures report only their dollar equivalents. Currency-wise break-up of the exchange reserves too is unknown. Since, in practical terms, the rupee is pegged to the dollar, and official disclosures are restricted to reporting foreign assets and liabilities in equivalent dollars, the reserves too may be in dollars (bank balances and investment in government securities).

This raises a question about management of the exchange reserves. The globally accepted principle of matching (to the extent possible) requires the Public Debt Office (and SBP) to maintain proportional reserves in currencies of the major chunks of external debt. In the past, foreign consultants were hired to guide us in this area that has grown in complexity with rising volatility of currencies.

In 2002, when only $0.89 could buy a euro, Governor ECB visited Beijing to entice the Chinese into converting a part of their reserves in the euro. By July 2007 the euro rose to $1.5790. Then, as well as now, around 19.5 per cent of Pakistan’s exports and 11.5 per cent of its imports are from the euro zone. Even if we disregard the trade statistics, investing a part of the reserves in the euro could have yielded huge gains. Hopefully, we did make those gains.

Coming back to the current financial stress, while we struggle with the fallout from the all-time high trade, balance of payment and current account deficits, payment of the re-scheduled non-ODA Paris Club debt began in FY07-08, and the bonds and Sukuks issued in 2004 and 2005 are due for payment in FY08-09 and FY09-10. The build-up of this load calls for urgent steps to bolster the exchange reserves.

Bankers admit that export proceeds realisation has been slow because exporters are either telling the importers abroad to delay payments, or are receiving payments in accounts they maintain abroad. But this doesn’t apply to all exports; those under letters of credit of reputable foreign banks are arriving as per schedule. That’s why reserves available with banks have consistently been close to $3 billion.

SBP has been pursuing banks to pressurise exporters to expedite export proceeds’ realisation. But the effort can’t succeed in all cases. While banks must pressurise exporters to ensure timely realisation of proceeds of exports that were financed by banks, for expediting proceeds of exports not financed by them, banks can pressurise exporters only morally; they have no legal backing there for.

This weakness is a flaw of the legal framework governing foreign trade. While competition obliges exporters to export on unsecured (collection, contract or open account) basis, the point to note is that export involves outflow of value , which must be compensated by inflow of a higher value. If this doesn’t happen, while Pakistan loses out, exporters who invest these proceeds in assets abroad, reap the benefit.

Therefore, the law must provide for exporters’ accountability but with adequate relief for circumstances beyond their control. It must compel them to ensure inflow of value by dealing with dependable importers. Cases wherein importers default or go bankrupt, commercial attaches in missions abroad must help or at least discover and report the truth, but exporters obstructing the inflow of export proceeds must be punished in an exemplary manner.

Finally, SBP must make the government realise that trade deficit can’t be contained by regulatory action alone. Changes in import tariff structure must support this effort. At present, only a supplementary budget with hiked-up import tariffs and fresh investment incentives can contain the trade deficit. Longer this is delayed worse will be its fallout on the economy i.e. weakening of the rupee, higher inflation, and escalation of all the deficits.