PBC: an appraisal

The government has launched a new scheme for mobilisation of foreign exchange resources – the ‘Pakistan Banao Certifications (PBC)’ with maturities of three and five years. These certificates can be purchased until June 30, 2019. Before further discussion, we would like to present a historical review of past efforts and point out what lessons can be learnt.

Since the early 1970s, workers’ remittances have been an important source of the foreign exchange income of the country. These are just like export earnings, carrying no future obligations. In the early 1980s, as an incentive and convenience to expatriates, the government decided to allow foreign currency accounts (FCAs), only for non-residents or those who had just returned after spending at least three years abroad. However, deposits in the FCAs were to be fed through inward remittances, and withdrawals were to be in rupees. Authorised banks were required to surrender the deposits to the SBP with guarantee of return and forward cover. This arrangement was neutral in its effect on the regular flow of remittances in the country. The scheme became a modest source of forex resources for the country.

In 1991, there was an ill-conceived overboard liberalisation of the forex regime in the country, enacted later on as the Protection of Economic Reforms Act (PERA), 1992. The hitherto highly regulated regime was dismantled with a single stroke of the pen. The new law virtually eliminated the role of any regulatory authority over the FCAs while simultaneously freeing up the holding, carrying, bringing or taking foreign exchange into or from the country in any quantity. Money-changers sprouted like mushrooms throughout the country with extremely rudimentary registration and licensing requirements. More significantly, residents were allowed to open FCAs and feed them from local purchases from money-changers. This single so-called reform has grievously affected the forex regime in Pakistan and has made the country’s external account vulnerable to occasional crisis.

A number of distortions were created by this regime. First, the scheme, while attracting significant flows of forex deposits, essentially amounted to cannibalising the existing flow of remittances, which consequently dropped. Though policymakers were unfazed, a silent killer was quietly moving to unravel the country’s remittances by converting them into loan obligations. Second, a process of dollarisation started in the country whereby every rational person soon discovered that it was highly profitable to convert savings into dollars to protect against rupee depreciation. Third, capital flight also started. The law permitted any amount of balance in an FCA for outward remittance. This was tantamount to capital account convertibility as any amount of rupees could be converted to dollars, deposited in an FCA and then remitted abroad. Finally, since all deposits were surrendered to the SBP, the FCAs were treated like balance of payments (BOP) support without worrying about the mounting foreign liabilities.

In 1998, the balances had risen to more than $11 billion, when the reserves dipped to $600 million. It was such poor coverage, which, in the backdrop of nuclear tests in May, made the policymakers panic and decide to freeze the FCAs. This was the most damaging policy action in the country’s history. Since then a new scheme of FCAs was designed – known as FE-25 – whereby banks are required to maintain a 25 percent reserve with the SBP against the balances and the rest can be used for approved purposes including trade financing. Additionally, these balances are separately identified while publishing the gross reserves of the country. However, the problems afflicting the forex regime persist, including access of residents to FCAs and flight of capital – although some reforms were enacted in the last budget. Furthermore, the SBP also borrows from commercial banks, giving rise to similar dangers as when banks kept full deposits with the central bank. Remittances, on the other hand, have taken an independent course, showing a healthy growth.

Are there any lessons for the PBC scheme? We examine eligibility conditions to see what implications they may have. Eligible investors include: (i) Pakistani individuals holding a CNIC; (ii) Pakistani individuals holding the national identity card of overseas Pakistanis (NICOP); and, (iii) all Pakistan Origin Card holders. The above individuals can purchase PBCs from an account outside Pakistan. The funds from the scheme would be used for BOP support.

We have three apprehensions about the scheme. First, the objective of attracting resources from expatriates is unwisely compromised by allowing residents to invest in the scheme. This will give mis-incentives to residents to convert their FCAs, which offer a pittance in return, to take advantage of substantially high-yielding certificates. A process of cannibalising FCAs would have an adverse impact on the treasury as it would be tantamount to converting an already available resource into a costly source. All an FCA-holder needs is to have an account abroad and balances can easily be transferred. Second, this channel can be used even by those who may not have an FCA at the moment but would now have the incentive to open one and convert their rupee wealth, via the FCA, into PBCs. Third, there is a danger that some remittances may also be diverted to the PBCs.

There is no rupee-based rate of return that is close to what has been allowed on the PBCs. The returns offered are 6.25 percent and 6.75 percent for three and five years, respectively. There will be an additional one percent offered to those who redeem their investment in rupee, which would add to an effective return of 33 pbs and 20 bps for three and five year maturities, respectively. Historically, the rupee deprecation is around eight percent annually, if not more, as happened in the last two years. We thus estimate returns of 14.58 percent and 14.95 percent which can be realised by local residents if they succeed in converting their FCAs into the PBCs. Moreover, there is no withholding tax applicable on this return – which is mostly applicable on rupee schemes – further increasing the effective return.

Those who may argue that our apprehensions are misplaced, we would submit: how else would the residents make investment in the PBCs? The only way to remove the apprehensions is to remove residents from the list of eligible investors. This would preserve the integrity of the scheme as a true mobiliser of foreign resources.

The writer is a former finance secretary.

Email: waqarmkn@gmail.com