Export refinance: enough party!

Textile industry has been the greatest beneficiary of government’s concessions and subsidies throughout most of Pakistan’s history. It’s about time the industry wore big boys’ pants. The industry has mastered the art of squeezing concessions from the government, irrespective of which party is in power. A two-third of SBP’s (State Bank of Pakistan’s) concessionary refinance schemes in both short-term and long-term loans is owed by textile players.

Out of Rs 647 billion Export Refinance Scheme (ERF), textile’s share is Rs429 billion. This is for working capital requirement. In case of long-term industrial expansion loans schemes (LTFF/TERF), textile fetched Rs327 billion (out of total Rs493 billion). There are opportunity costs for other industries and direct cost for the central bank in providing these concessions. The government and SBP need to rethink the strategy.

This article explores the ERF. The scheme started a few decades back. At that time, the working capital need was of 180 days and the refinancing was provided to exporters for half the amounts of yearly exports. That is to roll over the loan twice a year. The objective is to buy raw material and to incur other running expenses through it till the time the buyer pays.

Over the period of time, the working capital cycle shrank and the supply of ERF to many exporters is in excess to what they need. Had the ERF been supplied at market rates, this would have not been an issue as the borrower would have limited its exposure as per the need. However, the rate of ERF is just a fraction of market rates; there are arbitrage opportunities for smart borrowers. And textile boys are smart enough to extract any economic rent coming their way.

There are two kinds of arbitrage. One is to take ERF at low rate and invest (park) the excess at market rates. The same holds true for LTFF in the past as well. Some speculate that back in the 2000s, some textile players became real estate tycoons by using (or abusing) the concessionary schemes offered to them for boosting exports.

Witnessing that practice, after 2008, the IMF (International Monetary Fund) asked the government to link the ERF with market rates. The ERF rate was increased to 10 percent in 2011, and by 2013, the interest rate difference (between ERF and 3M KIBOR rate) was around 1 percent. The gap was thinned enough to kill the arbitrage. Then in PML-N time, ERF rate fell further with the reduction in discount rate. By 2016, the maximum rate of ERF stood at 3 percent.

The current regime at the SBP has kept the rate frozen, even though the policy rate moved from 13 percent to 7 percent and is now climbing back up. Banks lend to exporters at maximum of 3 percent while SBP refinances banks’ financing at 2 percent. The spread of banks is up to 1 percent.

The rationale for bringing ERF rates down by Dar was to compensate textile players for the currency disadvantage.The currency was kept artificially overvalued, and exporters were losing competitive edge. Dar reduced to the ERF rates as a balancing act.

Moreover, the market rates were low too and that was another good reason to bring ERF’s rate down proportionately. The interest rate differential was around 3 percent during 2016 and 2017.However, PML-N under Dar did not expand the ERF limits too much.

The situation has changed in the last three years. The country has a flexible exchange rate regime. There are other forms of subsidies being provided to exports under the PTI regime. Moreover, the market rates have moved up. The average interest rate differential has remained at 6.8 percent since January 2019. Textile boys are having a ball. That is demonstrated by record profitability by listed companies.

The advantage is not confined to favourable rates (interest and exchange), better refunds policy and regionally comparable energy prices. The limits of ERF have expanded too. ERF outstanding amount for textile has increased from Rs235 billion ($1.7 billion) to Rs429 billion ($2.5 billion).

The increase is almost 50 percent in dollar terms. The high interest rate differential and higher allocation have enticed textile players to invest excess amount of ERF into risk-free government papers. Borrow at 3 percent and park the excess liquidity in T-bills at 9-10 percent.

The other punt players are taking is to hold dollars outside Pakistan as long as they can gain on currency depreciation. Exporters (till last week) were allowed to keep export proceeds outside Pakistan till 180 days. They could borrow in PKR at 2-3 percent and at that cost they could keep exposure in USD (by keeping proceeds outside) for 180 days to punt on PKR depreciation. Any depreciation over 1.5 percent is free money. This factor today is putting further downward pressure on PKR. That is why SBP last week has reduced the limit to 120 days.

Big and reputable integrated textile exporters say that this arbitrage is not possible, as majority of their clients are big retailers, and they send the money back directly to Pakistan on agreed terms. They cannot hold dollars back. However, they accept that some players, who have their own companies registered in the buying country, and those who sell semi-finished products, do enjoy this arbitrage.

The reservation they have against reducing the time to hold dollars back is that they have higher time of payment being agreed with buyers, and now they must change the terms. If the buyer doesn’t agree, it can move to other countries’ sellers, and Pakistan could lose its share. The fear could be true in the short term on existing contracts.

However, one big player candidly admits that all the textile players are for profit maximization and whenever they get the opportunity to make money, they won’t miss. Since the allowance is to hold back dollars six months, the cost of borrowing is low, and the currency is expected to depreciate, big exporters deliberately enter into contracts for higher days. By doing so, they get better pricing in dollars as buyers get longer credit period, and they can get benefit from currency depreciation.

The other element is that exporters are not restricted to use ERF for exports’ working capital; they park the excess allocation in T-Bills. He recommended that the government should take undertaking from exporters to solely use ERF for the purpose it is for. According to him, big players may also refrain from this arbitrage.

SBP should think of slowly tightening the tab of ERF. In the last three years, SBP has been too generous to exporters. It’s time to unwind the stimulus. But it should be done slowly as abrupt changes can hurt growing exports momentum. The ERF rates should be rationalized first. This will entice textile exporters to borrow in USD. Banks can lend in USD against their outstanding FE25 (foreign currency) deposits.

Some exporters say that since they sell dollar in forward, they cannot borrow in dollars. They sell in forward is because they borrow in PKR. They borrow in PKR because the rates are ridiculously low. If the rates move up, they can go and get USD loans, and settle the loans once they get exports proceeds – both loan and proceeds to be in USD. There would be no need of hedging by selling dollars in forward. And it makes more sense to borrow in USD when the rate on PKR is going high.

History suggests that when PKR interest rates are high and the interest rate differential (market rates and ERF) is low, export financing against FE25 grows.

Exporters follow the incentives. The government needs to give them an environment that is comparable to those available to their regional competitors. However, at the same time excess incentive at any given time could be counterproductive.

SBP should work on balancing the incentive structure. According to a recent World Bank report, Pakistan’s export potential is of $88 billion – three times of the exports. Concessionary finance schemes have limited efficacy. The focus should be on overall productivity of firms by having a more balanced incentive structure and by wisely using limited concessions a fiscally-strapped government has in the kitty.

Copyright Business Recorder, 2022