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SAZH-TAF Report on FDI

Economic - Foreign Exchange

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The Round Table discussions with our stakeholders led to the consensus that as remittance of finances is vital to investors, in the form of profits, whether dividends or royalties or sale of shares. This issue on the profitability or exit for foreign investors and their business, relates to foreign exchange. As the foreign exchange is controlled by the State Bank of Pakistan, which, according to our experts, has regularly restricted such remittances, it has further led to crushing the foreign investor’s interest or faith in the country.


Various experts from businesses complained that they owed significant sums to their shareholders or principal franchisers in foreign countries, yet they were not allowed to send the dividends or royalties because the State Bank has closed down remittances. This they complained only perpetuated and incentivized the illegal trade of currency and the underground economy, as they legitimately had no channels of sending money outside Pakistan, which they would be under obligation to do, due to their contracts and businesses. Likewise, letters of credit (LC) were not being opened, thus no trade could legitimately take place. Such explanations were hard to share with foreign partners, and at times it seemed necessary to active various force majeure clauses in their contracts to avoid further liabilities.


Our experts in legal and accounting firms shared that while there was a great deal of confusion and problem with the State Bank’s approach, a significant part of the issue was also the lack of awareness and expertise pertaining to the Foreign Exchange Manual, which governed the transfer and caps on dividends, royalties, and other such remittances.


It was suggested by an expert in one of our personal discussions that the Foreign Exchange Regulation of 1947 should be repealed or heavily amended. The Act was introduced by Jinnah at the time of independence as Pakistan was in economic warfare with India as the latter hoarded the former’s reserves. So, the Act was enacted to protect Pakistan’s reserves. However, ever since then we have built a cultural mentality that our entire lives are dependent on foreign reserves. There are multiple issues with this perspective, our GDP on a PPP (Purchasing Power Priority) basis is more than a trillion, and our GDP on a nominal basis is $360 billion, which means the difference between these GDPs calculated is the Black Economy. Pakistan’s black economy is 70% of its overall economy. Thereby, our expert commented, it leads to the State Bank only restricting the 30% and letting the 70% grow bigger.


Thus, in the Round Table discussions, our stakeholders identified that a substantial problem which foreign investors face is the country risk which comprises the foreign exchange regime and control to repatriate profits. Our Round Table stakeholders further pointed out that the second problem with the Act is that Pakistan is down to $9.1 billion in foreign exchange reserves (CEIC Data, 2022), which means it does not matter if the country has an economy of $360 billion because Pakistan’s entire foreign investment ambitions are limited by the ability to spend $7 billion. The State Bank restricts the flow of currency through the Foreign Exchange Manual (FEM), which comes from the 1947 Act. As per our legal expert, the Foreign Exchange Manual has capped royalties thus restricting people from sending royalties legally. Every company that has to send royalties abroad to its franchiser could potentially face contractual breach liabilities as a result of the cap on the clause of royalties. One expert shared that a solution suggested to him was to establish a company in the US, which will hold his company as a subsidiary. As subsidiary payments are not capped in the manner royalties would be, he would be free to remit the money to his holding company in the US, following which he may then send the money to the actual recipient which may be his franchiser. He shared that such a convoluted solution to a simple matter of transferring money legally, should not be his only option.


Another reality shared by our expert in finance law and global markets is that the country’s risk is not just foreign exchange, but credit default swap. Pakistan is increasingly borrowing from the international markets and has become exposed to the price of our debt being volatile depending on investor perception. Right now, he shared, Pakistan’s credit rating is junk, which is an odd thing to be when it has a limited amount of debt in the international markets. Supposing that 90% of the government’s borrowing is from our banks, then it is only 10% borrowing from friendly nations and international debt markets. Pakistan has started to go to the latter, which gives it access to an unimaginable amount of capital and discipline as the debt price will change every day. Foreign friendly nations help Pakistan, meanwhile the domestic banks give it PIBs (Pakistan Investment Bonds). However, the real place to borrow money is the international debt market and Pakistan has not developed a strategy on this. Countries become rich because their stock markets are connected, and debt markets are connected. Pakistan’s government is not interested in these reforms, which would help considerably, yet he was unable to point out why this was the case.


Likewise, our Round Table participants shared the problem connected with inconsistency in how the government initially promised to pay power companies in USD but later turned back on their heels and started paying in PKR. The government is converting its own cost from USD to PKR but for commercial companies, the cost conversion remains from PKR to USD. An expert in the Telecom sector told us that the biggest issue an investor faces is the massive devaluation of the currency in Pakistan. An investor brings in USD but their revenue is generated in PKR. The rapid devaluation of the currency, therefore, means that regardless of the performance of his investment an investor does not get back a considerable return to justify Pakistan as his investment choice. A continual and predictable devaluation trend could be handled by managing the capital, but when unexpected fluctuations happen that the investor hadn’t expected then it demotivates foreign investors from doing business here. An investor having millions to invest could look at other open markets, which are stable for making investments.


Another source within UNDP, shared that various countries exercised foreign exchange control by incentivizing local production of goods that were imported, or bought using USD, and converting your indigenous production into export driven growth. This opinion was echoed by various senior members in our Roundtable including the department of the Auditor General, as well as various other experts. It became clear that further consultation on this matter was vital, as the resolution to the foreign exchange is interconnected through correct policies on trade and manufacturing.


Citing the above, with the immense problem surrounding foreign exchange regulation, the Round Table, after due consideration suggested that while repealing the Foreign Exchange Act would not be practically or politically feasible, a surgical amendment of the Foreign Exchange Manual should definitely take place. For the same, the relevant experts and stakeholders in the economic and finance sector should be consulted, as this was a macro problem, which was causing micro disturbances.

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