PAKISTAN’S economic problems, chiefly those related to the external sector, have become quite challenging. Two global rating agencies, Moody’s and Fitch, have already downgraded the country’s credit ratings and shown their concerns about the balance-of-payments position.

The Paris-based international anti-money laundering watchdog, Financial Action Task Force (FATF), has put Pakistan on its grey list. The country has submitted an action plan to address structural weaknesses in the anti-money laundering and combating financial terrorism (AML/CFT) regime to the FATF.

Last year, one of Pakistan’s five major banks, Habib Bank Ltd, had to close down its New York branch and pay a heavy penalty to US authorities as a result of weak internal controls there. Now all banks have become even more careful in handling foreign transactions. Another major bank, United Bank Ltd (UBL), has been asked by the New York Fed to strengthen its anti-money laundering compliance.

Against the backdrop of growing global concerns regarding real or perceived money laundering, the country’s lingering external sector worries look all the more challenging. On June 29, foreign exchange reserves of about $9.48 billion, held by the State Bank of Pakistan (SBP), were insufficient to cover two months of imports.

In 2017-18, imports grew 15.1 per cent, but exports increased at a bit slower rate of 13.74pc. Even assuming exports during the current fiscal year will be growing as fast as imports, the country will continue to see a massive monthly trade deficit, far larger than total exports, throughout the year.

This scenario has a lot of implications for banks. “The SBP has asked banks to fulfil some additional requirements before opening imports’ letters of credit. Even otherwise, we will have to be more prudent in import financing now. Following a stricter procedure for this is important not only from a compliance point of view, but also because it will help us remain as liquid in the foreign exchange market as possible at a time of crunch,” says the treasurer of a large local bank.

“On the other hand, each bank is now prioritising export financing because of two reasons: the central bank likes to see this happening, and a bank’s own requirement for keeping foreign exchange inflows stronger to avoid temporary shortages,” he concludes.

The practice of being too careful in import financing and too generous in export financing will have an impact on banks’ relationships with customers, the cost of financing, their ability to maintain prescribed limits for the foreign exchange holding and interbank foreign exchange dealings; besides additional complications.

Most of the big exporters are also importers of raw materials. Banks will have to be flexible in the case of their import financing. But can they afford to be rigid on import requirements of politically sensitive customers that are non-exporters, such as telecom companies or strategically important contracting firms engaged in the China-Pakistan Economic Corridor (CPEC) projects?

A mere 1.4pc increase in home remittances in 2017-18 and no prospects of a jump in this rate in 2018-19 make the foreign exchange crunch disturbing, more so because banks are now handling remittances with extra care in compliance with the AML/CFT rules.

If we add $19.62bn received in 2017-18 from overseas Pakistanis to export earnings of $23.23bn, we get $42.85bn. Even this amount is $18.05bn short of the import bill of $60.9bn. It means that after partially financing imports through exports and remittances combined, we still have to arrange $18bn a year just to foot the total import bill.

Remember that a few billion dollars of foreign direct and portfolio investment coming into the country are consumed by the outward flow of foreign exchange on various accounts, including the profit and dividend repatriation by multinationals in Pakistan.

At the end of every quarter, and particularly towards the close of the fiscal year when external debt servicing takes place, we see the central bank drawing down on its foreign exchange reserves to meet debt servicing obligations.

To ensure that reserves don’t fall below a certain level, the central bank also keeps borrowing foreign exchange from the interbank market, chiefly through rupee-dollar swaps. It promises to give banks rupees in exchange for dollars on the date of maturity of the swap deal.

When these deals mature and the SBP has to repay dollars to banks, the interbank market again witnesses considerable activity. Banks with enough foreign exchange liquidity begin anticipating that the SBP may go for another forward rupee-dollar deal with them. And those facing a foreign exchange crunch reposition themselves, knowing that both ready and forward exchange rates would be affected once this happens.

This is going to happen perhaps with a higher frequency in the current fiscal year too, foreign exchange dealers say.

All eyes are set now on the foreign exchange part of the ongoing tax amnesty scheme. But up to July 11, a little less than $5bn worth of undeclared foreign assets held abroad had been declared. The scheme will expire on July 31.

Unless authorities are able to get a substantial part of undeclared foreign assets repatriated back home, we won’t see an impact on foreign exchange availability. Up to July 11, just $40 million worth of foreign-held assets had been repatriated.

The foreign exchange shortage is due to structural external-sector problems and will take time to go. Coupled with a high fiscal deficit, this is going to result in lower-than-projected growth in the gross domestic product. That means demand for the private-sector credit will taper off, bankers fear. Naturally then, banks will keep investing heavily in risk-free government debt instruments instead of lending generously to the private sector.

Published in Dawn, The Business and Finance Weekly, July 16th, 2018