How Can Pakistan Build Up and Manage Dollar Reserves?

Every country needs US dollars to import products because the US dollar is the international trade and reserve currency. Only the United States can print dollars; all others must acquire them through exports and capital inflows like investments, remittances and loans. Pakistan has had serious problems in acquiring sufficient amount of dollars for its needs through trade and investments over the last several decades. It has been forced to seek IMF bailouts repeatedly.

China, India and East Asia:

China and other East Asian nations have built up large dollar reserves by running massive trade surpluses mainly through exporting lots of products and services to the rest of the world.

Others, such as India, have built up significant US dollar reserves in spite of running large trade deficits. India relies mainly on foreign investments, remittances from non-resident Indians and foreign debt for its dollar reserves.

India is consistently ranked among the top recipients of foreign direct and portfolio investments as percentage of its GDP.

Pakistan's Foreign Investment and Trade:

Like India, Pakistan also runs large trade deficits. It also depends on foreign investments, remittances from overseas Pakistanis and foreign debt for its dollar reserves.  So why does Pakistan have serious recurring balance of payments crises?

Unlike India,  Pakistan ranks very low among recipients of foreign direct and portfolio investments as percentage of its GDP. .  Part of it is the perception of insecurity since 911. The real security situation has dramatically improved in the last few years but the perception continues to lag.

Pakistan's exports have also lagged behind India's as percentage of gross domestic product (GDP). In fact, Pakistan's exports have halved from about 16% of GDP in 2003 to 8% of GDP in 2017. India's exports have increased from 15% to 19% of GDP in the same period, according to the World Bank.

Exports as Percentage of GDP. Source: World Bank


Export-Orientation of Industries:

Pakistan has a fairly diverse industrial sector which caters to its domestic market.  People running these businesses and industries have little or no knowledge of the customer needs and regulatory requirements of foreign markets where their products or services could be sold to boost Pakistan's exports and dollar earnings.

Pakistan's economic attaches posted at the nation's embassies need to focus on all export opportunities in international markets and help educate Pakistani businesses on the best way to take advantage of them. This needs to be a concerted effort involving various government ministries and departments working closely with industry groups.

Illicit Capital Flows:

Pakistan's new government led by the Pakistan Tehreek e Insaf Chief Imran Khan needs to urgently crack down on illicit outflow of dollars. One of the ways large amounts of money moves across international borders is through trade misinvoicing.

Global Financial Integrity (GFI) defines trade misinvoicing as "fraudulently manipulating the price, quantity, or quality of a good or service on an invoice submitted to customs" to quickly move substantial sums of money across international borders.

How does trade miscinvoicing work? Here's an example:

Let's say an exporter in Pakistan exports goods worth $1 million to a foreign country and invoices it at $500,000 through an offshore middleman.  The middleman invoices and collects $1 million from the end customer, sends $500,000 to Pakistan and deposits $500,000 in an offshore account. The result: Pakistan is deprived of the $500,000 in foreign exchange.

Similarly, imports of goods worth $1 million to Pakistan are overinvoiced at $1.5 million through an offshore middleman and the difference is kept in an overseas account. The result: Pakistan loses another $500,000 in foreign exchange. Meanwhile, the Pakistani traders and the officials facilitating misinvoicing together pocket $1 million or 50% on the two trades.  Pakistan's trade and current account deficits grow and the foreign exchange reserves are depleted, forcing Pakistan to go back to the International Monetary Fund (IMF) for yet another bailout with tough conditions.



Terror and Drug Financing:

It is not just greedy politicians, unscrupulous businessmen and corrupt officials in developing countries who rely on fraudulent manipulation of trade invoices; all kinds of drug traders, terrorists and criminals also use what is called TBML (trade-based money laundering).

John A. Cassara, former US intelligence official with expertise in money laundering, submitted written testimony for a US Congressional hearing on “Trading with the Enemy: Trade-Based Money Laundering is the Growth Industry in Terror Finance” to the Task Force to Investigate Terrorism Financing Of the House Financial Services Committee February 3, 2016. Here's an except from it:

"Not long after the September 11 attacks, I had a conversation with a Pakistani entrepreneur. This businessman could charitably be described as being involved in international grey markets and illicit finance. We discussed many of the subjects addressed in this hearing including trade-based money laundering, terror finance, value transfer, hawala, fictitious invoicing, and counter-valuation. At the end of the discussion, he looked at me and said, “Mr. John, don’t you know that your adversaries are transferring money and value right under your noses? But the West doesn’t see it. Your enemies are laughing at you.”"

Summary: 

Pakistan needs to find a way to build up and manage significant dollar reserves to avoid recurring IMF bailouts. The best way to do it is to focus on increasing the country's exports that have remained essentially flat in per capita terms. Pakistan's economic attaches posted at the nation's embassies need to focus on all export opportunities in international markets and help educate Pakistani businesses on the best way to take advantage of them. This needs to be concerted effort involving various government ministries and departments working closely with industry groups. At the same time, the new government needs to crack down on illicit outflow of dollars from the country.

Azad Labon Ke Sath host Faraz Darvesh discusses Imran Khan's challenges with Misbah Azam and Riaz Haq (www.riazhaq.com)

https://youtu.be/CQ41Qt_2XQM




Related Links:

Haq's Musings

South Asia Investor Review

Money Laundering Through Trade Misinvoicing

Pakistan Economy Hobbled By Underinvestment

Raymond Baker on Corruption in Pakistan

Can Indian Economy Survive Without Western Capital Inflows?

Culture of Corruption in Pakistan

Chinese Yuan to Replace US $ as Reserve Currency?

Remittances From Overseas Pakistanis

Politics of Patronage in Pakistan

Why is PIA Losing Money Amid Pakistan Aviation Boom?

Comments

Anonymous said…
"Others, such as India, have built up significant US dollar reserves in spite of running large trade deficits. India relies mainly on foreign investments, remittances from non-resident Indians and foreign debt for its dollar reserves."

India also has significantly higher exports than Pakistan
Riaz Haq said…
#Pakistani troops to receive #training at #Russian #military institutes as #Trump policies push #Pakistan closer to #Russia and #China. #Pakistan https://www.thehindu.com/news/international/pakistani-troops-to-receive-training-at-russian-military-institutes/article24631024.ece

Pakistan and Russia have signed an agreement to allow Pakistani troops to receive training at Russian military training institutes, a move aimed at boosting their bilateral defence ties.

The agreement was signed on Tuesday at the conclusion of the first meeting of Russia-Pakistan Joint Military Consultative Committee (JMCC), according to Pakistan’s defence ministry.

“Both countries signed the Contract on Admission of Service Members of Pakistan in RF’s (Russian Federation) Training Institutes,” the ministry said.

The Russian side was led by Deputy Defence Minister Col Gen. Alexander V. Fomin who visited Pakistan from August 6-7 to attend the first session of Russia-Pakistan Joint Military Consultative Committee (JMCC).

Lt. Gen (retd.) Zamir ul Hassan Shah, Secretary Defence, led the Pakistani delegation during the JMCC meeting.

Prior to the inaugural meeting, held on Tuesday at the Ministry of Defence in Rawalpindi, the visiting dignitary called on the defence secretary and the defence minister.

During the meetings, the two sides discussed the present status of their bilateral defence relations with the aim to further strengthen, expand and diversify mutual cooperation.

JMCC is the highest forum of defence collaboration between Pakistan and Russia.

During the inaugural session of the JMCC, both sides exchanged views on bilateral and major international issues including situation in the Middle East and Afghanistan.

A comprehensive issue based review was also carried out during which the two countries expressed satisfaction on the milestones achieved since the signing of ground breaking Agreement on Defence Cooperation in 2014. The two sides also held in depth discussions on avenues of future cooperation, the defence ministry said.

Col. Gen. Fomin also met Chairman Joint Chiefs of Staff Committee and the three services chiefs.

An Army spokesman said that Col Gen Fomin met Army Chief Gen Qamar Javed Bajwa and discussed the regional security situation and matters of mutual interest including enhancement of bilateral defence and security cooperation.

Gen. Fomin expressed his appreciation for Pakistan Army’s achievements against terrorism and expressed requirement of greater cooperative and collaborative approach among global community to defeat extremism.

Pakistan’s defence ties with Russia have moved past the bitter Cold War hostilities in recent years and the chill in the relations between Pakistan and the U.S. has further pushed the country towards Russia and China.

Pakistan has shown eagerness to build military-to-military level ties with Russia.

Earlier this year, the then foreign minister Khawaja Asif visited Moscow during which the two sides agreed to set up a commission to boost military cooperation.

Russia has over the past three years provided four Mi-35M combat and cargo helicopters to Pakistan and the militaries of the two countries also held joint drills codenamed ‘Friendship’.
Riaz Haq said…
#Pakistan lines up $4 billion #loan from #SaudiArabia-backed bank the #Islamic #Development Bank. Official involved says Saudi government wants to "play a part in rescuing Pakistan from its present crisis”. #IMF #Bailout #China https://www.ft.com/content/6feaef1a-9bcf-11e8-9702-5946bae86e6d via @financialtimes

Pakistan plans to borrow more than $4bn from the Saudi-backed Islamic Development Bank as part of its attempts to restore dangerously low stocks of foreign currency.

Two officials have told the Financial Times that the Jeddah-based bank has agreed to make a formal offer to lend Islamabad the money when Imran Khan takes over as prime minister. They added that they expect Asad Umar, Mr Khan’s proposed finance minister, to accept.

“The paperwork is all in place,” said one senior adviser in Islamabad. “The IDB is waiting for the elected government to take charge before giving their approval.”

The person added that the loan would not cover Pakistan’s expected financing gap of at least $25bn during this financial year but was “an important contribution”.

Mr Khan, Pakistan’s former cricket captain, is expected to take over as prime minister in the coming days after his Pakistan Tehreek-e-Insaf party won the most seats in last month’s election — though it fell short of an outright majority.

One of his first jobs will be to repair the country’s balance of payments problem, with high imports and stagnant exports having bled the country of much of its foreign exchange reserves.

Speaking to reporters in Islamabad this week, Mr Umar, who served as the PTI’s shadow finance minister while in opposition, warned: “The situation is dire. We’ve got $10bn dollars of central bank reserves, we’ve got somewhere between $8bn and $9bn in short-term liabilities, and therefore your net reserves are close to nothing.”

Officials have already drawn up plans to borrow up to $12bn from the International Monetary Fund — though such a bailout is likely to come with strings attached, such as a demand to see the details behind billions of dollars’ worth of Chinese loans.


Mr Umar is therefore exploring what other options remain open to him, of which the IDB loan is one. Officials said the loan would be used mainly to pay for oil imports, with higher crude prices having contributed to Pakistan’s problems.

One official at the Pakistani central bank who has been involved in negotiations with the IDB said the loan had the backing of the Saudi government, “which wants to play a part in rescuing Pakistan from its present crisis”.


Islamabad and Riyadh have moved closer in recent months after Pakistan agreed to send an undeclared number of troops to “train and advise” security forces there. The Pakistan government insists that the soldiers will not be used to fight in Yemen however, something the Saudis had previously requested.

Despite the promise of money from the IDB, economists warn that Mr Khan’s new government will still have to enact potentially unpopular spending cuts and tax rises to help repair the government’s balance sheet.

“The budget deficit shot up to about 7 per cent of gross domestic product during the last financial year,” said Waqar Masood Khan, a former finance ministry official. “Bringing that down to the target of 4 per cent is not going to be easy.”

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