Is the kerb market in forex and transferring money by ‘hawala’ or ‘hundi’ going for good? The Ministry of Finance and the central bank say “yes.” But their optimism could well be undermined by the ingenuity of the dealers, who are consistently on the lookout to break the system.
If the government, however, succeeds in the open market in forex, then how will it affect capital inflows, outflows and flight of capital, smuggling and gold brought in from Dubai, that is financed with undocumented private dollars? The basis of what is likely to be the “unification of the forex market,” was set out this week. It meant the end to the kerb market and ‘hawala’ and ‘hundi’ that feed it with some $6-7 billion annually — while some even estimate it at $11-12 billion — in the present form. Pakistanis arriving from Europe bring nearly three million euros daily, of which banks buy one million while two million go back to Dubai for conversion into dollars that return to Pakistan.
Future’s open market in dollars, euros, dirhams and riyals, will be operated by Money Exchange Companies (MECs). Home remittances through official banking channels, sent by Overseas Pakistan doubled to $2.0 billion in the just ended fiscal 2002 compared to 2001.
That is only one-fourth or one-fifth of remittances inflow. Officials attribute the increase in 2002 to international monitoring of money transfer following Sept. 11.
The SBP plan that started Aug. 1, will virtually finish off 469 existing operating licensed money changers, and some 400 unlicensed ones. Karachi has a total of 150 licensed money changers followed by 78 in Lahore and 71 in Islamabad-Rawalpindi. Malik Mohammad Bostan, president of Forex Association of Pakistan, says, “Forex liberalization will be the death-knell to the ‘hundi’ and ‘hawala’ system.”
While money changers will lose business, commercial banks, both Pakistani and foreign-based, will gain as they are, for the first time, to be allowed to engage in forex business. The banks, under the new ordinance, have been allowed to seek licenses for MECs.
They can set up separate forex counters within their premises. Commercial banks, so for, were feeling discriminated against in forex business for which they had to deal with SBP.
Applications by investment banks with “excellent balance sheets” will also be considered for starting up of MECs. The MECs will be permitted to sell their surplus foreign exchange in the interbank market. It will provide additional liquidity and deepen the interbank foreign exchange market.
The unification aims at merging the present interbank market which handles almost 95 percent forex transactions, and can, thus, be described as “the official rate-setter,” and the open market. The idea is to force out even the presently narrowed down margin of Rs. 0.5 — 0.12 to a dollar, between the kerb and the interbank rate. Only weeks ago, this margin was Rs. 0.30, and for several months prior to that it was Rs. 1.0.
The SBP will continue to intervene in the forex market both by selling and buying, whenever it finds necessary to stabilize the market. But, how far can the SBP go? Already criticism of its dollar buying and intervention operations have been severe as SBP lost Rs. 22.881 billion during 1998 and 2000, according to a report just unveiled by the Auditor General of Pakistan.
The merger of the two markets will be complete in two years. IMF has been pressing Pakistan for a long time to merge the two markets. Then Sept. 11 happened and Washington started pressing Islamabad to enforce it as it thought that banning ‘hawala’ and ‘hundi’ will starve global terror of funds.
At the same time, the Pakistani government for years, has been trying to stop ‘hawala’ transfers and to enlarge inflows of home remittances through official channels, from overseas Pakistanis.
However, the kerb market operators are still hoping to keep their roaring trade going. They ask, what will be the dollar rate in the unified market and the rupee’s “real” value? Will not rupee depreciate if the economy continues to be weak? The post-Sept. 11 scenario and aid inflows have raised the official forex reserves to $7.0 billion — of which $2.0 billion are owned by private dollar depositors. The balance of payments has improved. But most of these elements are a one-time affair.
The SBP has begun the unification of the forex market this week and has invited applications for establishing Money Exchange Companies (MECs), under a Presidential Ordinance. SBP’s FE Circular 9 lays down detailed instructions. An MEC will have a minimum paid up capital of Rs. 100 million.
SBP Governor Dr. Ishrat Hussain, says, “with the establishment of MECs, not only the remittance transactions will be fully documented, but it will also help curb activities of unauthorized money changers and the ‘hawala’ and ‘hundi’ business. The MECs will have a much wider scope of business than the money changers ... the main objective is to provide a corporate culture to money changing and remittance business. And, achieving a uniform exchange rate in interbank and the open market is our ultimate aim.”
But can abolishing the present money changers and ‘hawala’ and ‘hundi’ achieve this objective? ‘Hawala’ is a highly efficient, and remitter-to-receiver direct service. Money is delivered at receiver’s doorstep, at good rates. Banks, despite modern technology, have failed to provide a competitive rate or set up an efficient delivery system. Although the government claims the proposed MECs will introduce a high degree of competition only the future will tell whether the overseas Pakistanis and their families back home benefit or suffer the new system.
The MECs will be authorized to deal in foreign currency notes and coins, postal notes, money orders, bank drafts, travelers’ checks and transfers. But any other activity such as deposit taking, or lending directly or indirectly is banned. They will sell and purchase forex to and from individuals, and corporate bodies for paying royalty, franchise, technical fee, repair and maintenance expenses. The MECs, franchise and booths will be subject to SBP monitoring, as applicable to all banks.
SBP has set a 2-year transition, that ends July 1, 2004, for the present money changers to pool resources, operating with franchise of other exchange companies, or to wind up their business. No new licenses will be issued for money changers nor the existing ones renewed during this period. The number of MECs is expected to be much less than the existing money changers, especially because of Rs. 100 million as the minimum capital base.
The amount of forex, they will handle, too, cannot be forecast. Will people engaged in smuggling seek documentation and also pay all local taxes on them, by operating through MECs? The fact that a number of such customers will not like to be documented and taxed points to the emergence of yet another parallel market in the event the government fails to realize its objectives.
The money changers are also divided on paid up capital limit of Rs. 100 million for an MEC. FAP President Bostan says it should be Rs. 50 million. “Hardly 10 money changers in Pakistan can set up a company with Rs. 100 million in paid up capital. The remaining 460 cannot do so even through mergers... Money changers had wanted to coexist with MECs, but SBP has given them two years to merge or pack up and quit. This is not fair,” Bostan said.
But, big operators say the paid up capital should be Rs. 250 million, “to eliminate chances of money laundering and to ensure a clean, transparent system of money exchange,” said one of them on condition that he not be named. The paid up capital for an existing money changer which also operates branches is Rs. 5 million.
The day the MECs plan was unveiled, rupee rose both against the greenback and the euro. The dollar in the kerb closed July 30 at Rs. 59.40/59.50 compared to Rs. 59.55/59.65 on July 29. Euro was Rs. 58.10/58.30 on July 30, compared to Rs. 58.60/58.80 on July 29. Over the weekend dollar was quoted at Rs. 59.50/59.40, and euro at Rs. 57.80/57.60. In the interbank market, dollar was Rs. 59.52/59.55 on July 30, compared to Rs. 59.52/59.54 a day earlier.
In case the rupee appreciates after liberalization, will it not curb exports? Will it not raise the cost of doing business and investing here? How will a depreciated dollar, in the future, encourage FDI inflows, already next to nothing? Can paltry portfolio investment that makes a quick buck and goes out, boost investment?
The real test of the liberalization will come when the domestic economy improves and imports rise. The trade deficit will then widen, and the premium on dollar in the “open” market will rise. Remittances through official banking channels will become less attractive. Who will then mind the forex regime — and at what cost?