By Muhammad Bashir Chaudhry
Apr 14 - 20, 2003



Pakistan has accumulated liquid foreign exchange reserves of US$10.171 billion ($ 9.978 billion on 8th March, with the State Bank of Pakistan and the balance of $1.193 billion with the banks). The reserves have been showing increasing trend every month in a country that for a long time had been making with reserves barely sufficient to meet imports of only a few weeks. For this lucky break there are various reasons such as grant from USA, Foreign Direct Investment (FDI), better economic management and higher remittances by the expatriate Pakistanis. High reserves have also presented the government with a number of opportunities for promotion of priority areas such as industrial investment, public sector development projects, pre-payment of non-concessionary debt, etc. However, final decision regarding the quantum of funds to be so committed for different purposes would be made after careful analysis.

Due to perennial shortage of forex reserves in the past, the SBP team might have had a pleasant surprise when asked to explore avenues for placement of part of the reserves to earn some income for the country. Presumably, due to safety and liquidity considerations, there has not been much progress in this area. However, in the meantime the SBP has started using the foreign currency mobilized locally from commercial sources for effecting payments for import of oil or other remittances on different accounts. Now that the forex reserves are expected to grow further in the coming days due to higher inflows, the authorities might start using part of these reserves for fostering economic development and for poverty reduction in the country.

A special committee reportedly is finalizing a major policy package for industrial revival that may possibly include utilization of foreign exchange reserves for project financing, re-introduction of exchange risk cover for machinery import, enhancing exports and exemptions of import duties, taxes, etc. for promoting investment. The committee, led by the Commerce Minister, comprises the advisers to the prime minister on finance and privatisation, besides ministers for industries and food and agriculture, and the SBP governor. The package, after detailed deliberations, would be submitted to the federal cabinet for approval. It has been reported that the committee as yet has not devised the long-term project-financing scheme that perhaps might be taken up in the next meeting. Policy on using forex reserves for project finance will be explored further.

High forex reserves are largely a factor of larger exports and services. The government is anxious to enhance country's exports. A high-level committee constituted last month by the Prime Minister for recommending measures to boost export-led economic growth, reportedly held it's meeting recently and developed a number of proposals. According to press reports, a number of important proposals were considered, which, if implemented, would remove some of the grievances of export industries. The committee has also endorsed the idea to establish two economic zones, one at Karachi and the other at Pindi Bhattian. The details are likely to be discussed further and finalized shortly. The streamlining of the system and other measure are expected to reduce the cost of production of exportable goods. The recommendations of the committee would be submitted to the ECC for approval.

The government might consider rationalizing its present drive for more Foreign Direct Investment (FDI) and the incentives framework for the foreign investors. Based upon a proper study, actual cost and the benefits of FDI in the recent years need to be worked out. A common presumption is that the FDI investors are taking away profits that are many times more than the going interest rates or the return that is available to the local investors. This presumption may have some weaknesses but a proper study on FDI should show the real picture and also validate the present drive. It is agreed that FDI is important in certain specific areas depending upon the needs of a particular country. However, at present more needs to be done to re-assure the local investors.



The government has to create conducive conditions so that remittances are not utilised entirely for non-productive purposes. Recent experience has been that the inflows have been used less for industrial promotion and the bulk has been used in real estate, share markets including TFCs, vehicles and in building of houses. Less industrial investment has been due to uncertainty on economic policies, difficulties in utility connections, red tape and corruption. Due to fewer opportunities for industrial finance, the commercial banks have also started financing the purchase of home appliances, automobiles and other consumer durables. For more industrial activity and prosperity for the people, the obstacles listed earlier may be removed with additional incentives such as lower utility charges, lowering of GST rates, minimum paper work, less interference by the government agencies and special tax credits to the investors.

As regards the use of forex reserves for retiring country's huge debt, the SBP Governor reportedly said on 18th March that the Debt Management Office has already started working out the strategy for repaying non-concessional debt of the IMF, ADB and the World Bank. He said that, keeping in view Pakistan's cash flow; high cost loans of these institutions would be gradually prepaid. This would gradually reduce the external debt burden. He added that Pakistan has already re-profiled long term loans of the Paris Club. The Governor said that the effort now is to repay $ 5 billion non-concessional loans as the costly private and commercial debt of $ 4.5 billion has already been repaid. High debt-servicing burden in the past also resulted in slashing of the government's development expenditure. The delay in the completion of infrastructure projects, quite often due to lack of timely funding, had an adverse impact on the overall pace of development effort. Now there are plans to accelerate development activities. Fresh borrowings from multilateral sources would be on soft terms only.

Every Pakistani would wish that the government retired foreign debt that is not sustainable and was adversely affecting implementation of development projects for public welfare and poverty reduction. The pre-payment of costly debt, perhaps would not be so simple as the country has recently availed, through the Paris Club, rescheduling of debts from bilateral official sources. In most cases, through linkages in the loan agreements the borrowers are not allowed to pre-pay to one or more selected creditors, while leaving out the rest. The country might continue exploring the possibilities of pre-payment but should also keep looking for other promising opportunities for safe deployment of the forex reserves.

The international financial institutions have lately, based on Pakistan's record for compliance of the conditionalities, shown more confidence in the economic management of the country. They are now offering soft loans to finance for restructuring of various sectors including judiciary, capital markets, SMEs, etc. The bilateral official sources are also offering large amounts under Suppliers Credits for implementation of important physical infrastructure projects such as Gwadar Port, Railways, Thar coal Power Plant, etc. Fresh borrowings have to be minimized and restricted to only cheap credits. Moreover, the country has to develop capability to be able to effectively manage all stages of the development projects.

Now that the country is blessed with high forex reserves, the government and the SBP in coordination with the Debt Policy Coordination Office might adopt a forex reserves policy. The new policy should be designed to result in continuous build up of reserves as well as systematic allocation of a small part of the reserves for co-financing of priority development projects to be implemented largely through cheap loans from international finance institutions and official bilateral sources. However, such fresh borrowings should not result in an appreciable increase at any time in the total foreign debt from the present level of around US$ 33 billion. It would be preferable if the overall debt were gradually reduced. The rationale for such a policy and the institutional framework for utilization of forex so allocated are discussed below.



The forex reserves must be used for acceleration in the implementation of priority development projects for welfare of the people and for poverty reduction. However, this should not be the only aim of such policy. Getting value for money in every such project and developing local capability for the proper appraisal, procurement and implementation should also be the main components of such a policy. In the absence of proper framework that assures value for money and timely implementation of priority projects, the government efforts might not achieve the desired objectives.

The country has limited forex reserves and therefore determination of annual allocation of reserves for project financing is important. Annual allocation of forex reserves for project finance might be set in relation to a benchmark for example at 20% of the annual remittances by the Pakistani expatriates. Alternately, it may be determined in relation to the total forex reserves about 5% of reserves at end of previous year. Based on actual experience, annual allocation and the proposed use might be periodically reviewed and adjusted.

The type of projects and activities under the scheme may possibly include: (i) purchase of essential equipment needed in energy and power, transport and communication including ports, (ii) credit lines from the SBP to the banks and DFIs for rehabilitation and/or expansion of existing industries, promotion of SMEs and cottage industries and (iii) credit lines to small developing countries for boosting exports of machinery from Pakistan. As per press news, Pakistan has recently offered $ 5 million soft loan to Bangladesh for the modernisation and expansion of existing sugar mills as a goodwill gesture from the Prime Minister. The Minister for Industries and Production made the offer, at a meeting with his Bangladeshi counterpart on 17th March in Dhaka. Both sides agreed to encourage joint ventures in textiles, fertilizers and paper industries. There may be many other countries that fall in this category.

There must be a policy and institutional framework under which the forex reserves will be actually expanded. The policy framework may have its main elements such as: (i) large infrastructure projects may only be co-financed with the World Bank and the ADB. Participation by Pakistan under this scheme should not exceed a specified limit about 20% of the foreign cost. Projects being set up with the financial and technical support of the friendly countries to be also eligible, (ii) the execution agencies of the projects to demonstrate proper discipline and efficiency in the negotiation of loans, the procurement of capital equipment and the execution of economic infrastructure projects and (iii) the National Bank of Pakistan (NBP) might be appointed for administering the special fund for financing the priority development projects as presently there are no large DFIs now in the field for handling the important task. The government and the SBP may consider strengthening the NBP to be able to properly handle appraisal, procurement supervision and disbursements for implementation of approved priority projects. Detailed Guidelines for appraisal and other functions as well as the procedures/controls must be developed and put in place with prior approval by the government. The NBP has the potential to handle the administration of the Pakistan Infrastructure Fund as the NBP is already administering the GOP's Long Term Credit Fund (LTCF) for financing the private power and power related infrastructure projects.

It may be noted that availability of own forex funds helps implement priority projects at lower capital cost and quickly. It may also be noted that procurement from tied sources is relatively costly, particularly when supplier credits are involved. Interest rates as well as other fees that are to be paid by the buyers of equipment are much higher than if the purchases were to be made from international competitive bidding process. The government has set up Public Procurement Cell and it might be strengthened to be able to see that the large procurements are made at reasonably competitive prices and the equipment is suitable to meets the requirements. The government's Public Procurement Cell might supervise the procurement of equipment under the SBP's forex reserves, independently or jointly with the NBP. For small credit lines from the SBP to the banks and the DFIs, these institution may be made responsible for approval, procurement supervision, disbursement and recovery.



Proper utilization of grant funds and other similar relief is important in order to increase welfare of the people/institutions and to win the confidence of the governments and institutions offering the grants. It is essential that there is proper institutional framework for such monitoring of the use of the grant funds. As per press reports, the government of Japan has asked Pakistan to furnish the utilisation report on million of dollars debt relief grant provided by Tokyo since 1992. The EAD has reportedly asked details from institutions such as KESC, KPT, NLC, Wapda, PBC, SBP, etc. According to debt relief agreement Pakistan was reportedly required to spend two-third of the grant for social sector reforms (health, education and water supply) and poverty reduction while one-third to be utilised for debt retirement. The effectiveness of utilization of both grant and loan funds needs to be strengthened at government and institution levels.