Is sovereign default inevitable? – IV

In this part of the multi-part series of articles I will describe underlying current of inflows and outflows of USD $. This will explain why Pakistan rupees (PKR) is trailing at 225 to 1 $ against less than 100 of India when we were above India as late as in 1995. There is a serious need to study this subject. Successive governments have never comprehensively studied the matter.

However, when Pranab Mukherjee was the Finance Minister, India conducted a very detailed study of the matter and issued a ‘White Paper’ in May 2012 on the amount of black money in India.

On account of inherent similarities of cultural trends and geographical location some pertinent facts about India are reproduced to deduce the results for Pakistan’s economy. The contents of Indian report will give an idea of what is happening there which is very close to what we are facing. The Indian report of 2012 said:

“In the GFI report of November 2010: The Drivers and Dynamics of Illicit Financial Flows from India: 1948-2008, it was estimated that between 1948 and 2008, a total amount of US$ 213.2 billion has been shifted out of India through illicit outflows.

After taking into consideration the rate of return on external assets, it is estimated that the adjusted gross transfer of illicit assets by residents of India amounts to about US$ 462 billion as of end-December 2008.

It has been further stated that if the size of India’s underground economy is estimated at 50 percent of the GDP (US$ 640 billion based on a GDP of US$ 1.28 trillion in 2008), roughly 72.2 per cent of the illicit assets comprising the underground economy is held abroad. This report also observed that it needs to be ascertained whether such an amount is stashed abroad in offshore bank accounts or whether this money has at least partly already returned to India.’’

This was the Indian position. The U.S. Treasury Department’s study titled “The Hawala Alternative Remittance System and Its Role in Money Laundering” in 2002 identified ‘hawala’ as a means of money laundering for drug trafficking and other crimes in Pakistan.

The U.S. Treasury Department study identified Pakistan, India and the UAE as ‘Hawala triangle’ to move money secretly worldwide. Worldwide, approximately $500 billion is remitted through this particular system and the Pakistanis were involved in transacting an estimated $7 billion through this system each year.

This hawala estimate for 2002 is unascertainable. However, some empirical estimations and their effects are discussed as under:

For an ordinary person the system has been explained here below in very simple language:

1. Total GDP of Pakistan is USD 375 to 400 billion. The size of the underground or cash economy on the basis of studies referred above is at least 30-40 percent of GDP. This means that around USD 150 billion worth of Pakistan’s economy is outside the regulatory systems.

Since Pakistan’s economy is all rupee-denominated, it means that there is a cash economy in this country of around Rs 30,000 billion if the conversion rate of Rs 200 to 1 $ is taken. This 30,000 billion is the sum total which includes funds collected, including bribes and corruption. This means a value of 30,000 billion rupees is generated every year in this economy. What Pakistanis can do with this rupee is estimated as under:

a. Around 55 to 60% of this tax evaded money is used in businesses. This consumes around Rs 20,000 billion;

b. Around 20% is used for acquisition of rupee-based assets such as motor vehicles, open plots, shares, etc. This consumes around Rs 5,000 billion. This is reason why there is constant increase in the prices of such assets. It is a parking lot for ill-gotten funds.

c. The remaining 20% is available in rupees being a sum of Rs 5,000 billion. This amount is usually converted into $ for transfer of funds to acquire assets, educate children and maintain bank accounts outside Pakistan and for expenses to be incurred abroad by Pakistanis. Thus in dollar terms black money in Pakistan generates $ 25 billion equivalent every year for use outside the country. In other words, there is an effective desire for outflow of this sum of money in some manner.

This sum of Rs 5,000 billion is in rupees. There is now no official manner except a small sum that can be officially transferred outside Pakistan. Nevertheless, there cannot be a defensible barrier against that ultimate outflow. This money has to go out. The entire financial system directly or indirectly supports this outflow.

They include banks and exchange companies, which effectively work as counters for hawala transactions. For example, one can easily calculate the amount of fees paid for Pakistani students overseas and the proportion of the same sent through official means. This all leads to ‘hawala’ in one manner or another and a strain on the availability and rates of $.

Let us be clear that ‘hawala’ cannot be eliminated by regulatory measures. It thrives on demand and supply of funds. With over $ 30 billion remittance coming in every year it can be deduced that the actual home remittance is around USD 55 billion of which only USD 30 billion comes in and $25 is used to abroad for financing hawala.

1. Nevertheless, there is another catch for the system. This represents the payments for ‘under-invoiced imports’ and ‘smuggling’. These are the imports which are not paid through the official channel. The parallel system, guided by ‘hawala’, also finances those unofficial imports.

There cannot be any official figure for it; however, it is considered that 5 to 10% of the value of total imports of $ 65 billion will not be a completely wrong estimate. This therefore means that $6.5 billion worth of imports for which the illegal importers receive in rupees on sale of products have to be paid to the foreign exporter in dollars. This is also financed through hawala.

1. As against these outflow pressures there is effectively no inflow pressure. The two factors which used to counter that market were ‘under-invoiced exports’ and proceeds of smuggling from Pakistan. In the recent past this inflow pressure has substantially reduced. On a rough estimate this can never then be more than 3 to 4 $ billion.

2. This all therefore means that Pakistan has to bear a $ outflow pressure of over 28 to 30 billion each year. This is now totally unmanageable and we may be going towards an inevitable default and free fall of currency. This is not a new trend. It existed for a long time. We were only deferring it.

3. The IMF and other lenders will not be able to save us unless we drain out the pressure of $ 25 billion created every year. India and Bangladesh are facing the same problems as described above. India despite its strong tax system has not been able to arrest black economy.

They have however managed to control the system by a sizable export. With over $ 650 billion exports and around $ 95 billion of home remittances India can afford to sustain a pressure of around $ 100 billion on its currency.

We in Pakistan cannot afford a pressure of $ 25 billion with a total inflow of export and remittance of $ 63 billion. We are therefore in a very difficult position. If the situation does not improve substantially I do not see any reason for the correction of pressure on currency and ultimate Sovereign default. There can be temporary remedies there is, however, a need for invasive surgery.

1. Even if we cut the requirements in the unofficial market to half, say

$ 10 billion, the situation will materially change. The hole is bigger. This hole can only be met by the availability of $ through exports which are effectively stagnant at a level of less than $ 35 billion in last two decades.

1. In case it is assumed that Pakistan will get full rollover for its due liabilities in dollars and there will be no outflow on that account in 2022-2023 even then the position of Pakistan is only temporarily out of danger. The exports and remittances will move around $ 65 billion.

The import bill will be around $ 70 billion. There will be constant pressure on the unofficial market for another $ 10 billion as indicated above. This position will therefore mean that we will be requiring at least $ 10-15 billion to maintain a reasonable level of reserves.

The shortfall is not huge; however, the problem is no foreseeable correction after 2023. If in each year there will be an outflow of $ 25 billion then the country will not be able to face even a small shock of international prices or recession for export markets. This means that the country is in serious problem that requires immediate correction. The ultimate solutions are:

a. Reduce the import bill by at least $ 5 billion, especially energy’s;

b. Reduce external pressure ‘hawala’ from $ 10 to $ 5 billion by documentation as hawala can survive on undocumented sector only;

c. Revamp the export paradigm where a rent seeking culture has evolved.

d. Psychologically accept that:

i. Pakistan cannot afford to live beyond means anymore as the ‘honeymoon’ of geographical locations has been overtaken by other events. There will be no more ‘dole-outs’ in future; and

ii. Foreign powers are not the reason of this precarious situation. These are the results of our own faults.

Copyright Business Recorder, 2022