How Can Pakistan Build up and Manage Dollar Reserves?
By Riaz Haq
CA
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 9/11. 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.
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 cross international borders is through trade mis-invoicing.
Global Financial Integrity (GFI) defines trade mis-invoicing 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 mis-invoicing 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 over-invoiced 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 mis-invoicing 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, submittedwritten 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 is an excerpt:
"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 nose? 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 a 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.
(RiazHaq is a Silicon Valley based Pakistani-American analyst and writer. He blogs at www.riazhaq.com)
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