The pursuit of ‘hot money’ — funds flowing from one country to another to earn a short-term profit on the interest rate gap in the two markets or the anticipated exchange rate shifts — is a risky proposition for some.

These speculative capital flows can move in and out very quickly, potentially leading to currency instability.

For others, it is a good idea to attract this kind of money to finance the national debt, build up capital markets by bringing competition to commercial banks in government debt financing and shore up foreign exchange reserves to bring stability in the external account in the short term at a time when other international capital inflows are scarce.

The idea is to mitigate political, economic and market risks for foreign portfolio investors while offering them a handsome return on their investments

With the exchange rate largely adjusted and the policy rate hiked to 13.25 per cent, the Economic Coordination Committee (ECC) has approved significant tax concessions for foreign portfolio investors interested in buying government debt. The withholding tax charged on profits made on the disposal of government securities has been cut from 30pc to 10pc for non-resident companies.

The reduced tax will be treated as the full and final liability for foreign investors who choose to invest in government bonds through the Special Convertible Rupee Account (SCRA) and will not be required to file tax returns.

The idea behind these fiscal incentives for foreign portfolio investors is to mitigate their currency, political, economic and market risks while offering them a handsome return on their investments for boosting the country’s foreign exchange reserves from existing $8.5 billion to the IMF-mandated level of $11.2bn at the end of the current fiscal year.

The government is expecting $6.2bn in private equity and debt portfolio inflows, borrowing by banks and other sectors to meet the estimated external financing requirements of $25.6bn for the present fiscal year and jack up official reserves by $4.4bn, according to documents detailing the loan agreement with the IMF. The remaining financing needs are to be met through disbursements from official creditors, IMF, foreign direct investment and privatisation proceeds besides syndicated loans and euro bonds.

Since the start of the current fiscal year, according to SCRA account details released by the central bank on Sept 11, American and British investors have brought in $99.6 million in treasury bills. While American dollars are lingering, the British buyers have pulled out $5.8m out of $14.9m they had brought in.

The central bank is confident Pakistan will successfully attract substantial hot money flows even if it doesn’t get close to $30bn attracted by Egypt in hot money in less than two years after it radically devalued its currency under a deal with the IMF.

Analysts like Ali Asghar Poonawala, however, don’t see a lot of money coming through. “Precariously low foreign exchange reserves and currency risks will keep foreign buyers at bay. Egypt succeeded in wooing inflows because of geopolitical reasons: they came overwhelmingly from the Gulf states, especially Saudi Arabia, as a mark of support for Gen Sisi’s regime. Geopolitics was the biggest determinant in Egypt’s case.”

A professor of economics at the Lahore School of Economics, who prefers to remain anonymous, concurs with him. “Credibility (of the government), trust issues, uncertain economic and business environment, exchange rate risks and political volatility will likely prove major impediments to the plan. Given the currency devaluation expectations and high inflation rate, we aren’t offering very attractive returns. More pragmatic approach would’ve been to float euro bonds.”

But people like Samir Ahmed, CEO of Knightsbridge Capital Group, are quite bullish on the plan. “They can bring in hot money. There’s a lot of money available in developed markets and interest rates are very low. So if somebody has dollars or if someone can borrow funds at a low rate and place them in Pakistani rupees — and even if you account for the currency risk (because of differential in inflation rates in Pakistan and the United States) and the conversion cost and so forth — I think there is a good return to be made by foreign buyers of the government debt.”

He also finds the geopolitical situation of Pakistan somewhat favourable right now partly because of “the part we are playing in the Afghan peace process. The IMF programme and financial support from Saudi Arabia and the United Arab Emirates should also inspire confidence in investors. But there is another side to it also. For example, we are facing this threat of action under the FATF. Overall, given the progress we’ve made in these areas, the geopolitical situation is more or less on the positive side.”

He points out that the SCRA numbers show foreign investors’ interest for the government debt, which is where it is trying to attract hot money. “It’s not a huge amount but it can grow. The good part is that the government is looking to finance its debt in local currency bonds. If there’s a new class of investors competing for the government debt, it will eventually decrease interest rates and the cost of borrowing besides helping develop the domestic bond market, currently dominated by commercial banks. So this new set of investors will strengthen the local bond markets.”

He believes that initially the money will come in very short-term debt. “Once there’s some degree of stability in economic conditions and investors get more familiar with us, possibly some of them will be tempted to move into longer-term bonds and at some stage start looking at corporate bonds with several years of maturity.”

Mr Ahmed agrees that hot money movements can be volatile and affect the exchange rate in the short term. “There are risk factors. Hot money, as the term implies, responds to very small interest rate movements. But the way I see it on balance, I think even if hot money flows out at a certain stage, we will not be worse off. For that period of time when this money is in, we will manage to finance the government deficit and get hard currency that we badly need. On the whole, this is a very well-thought-out strategy and like everything else it will have to be marketed properly to relevant institutions overseas in this kind of business.”

Published in Dawn, The Business and Finance Weekly, September 16th, 2019