Administrative crackdown: will it work?

The State’s crackdown against the smugglers and illegal currency traders has met with initial success. The fear factor is already paying dividends in the short term, and that is what fear can do. However, for this to sustain, crackdown should be on the deep routed problem of smuggling, power theft, tax evasion and tax net expansion.

The state is finally showing its teeth to tackle the economy. The first season started on 9th May. Although State’s action to impose order (with no heed to the law) at that time helped shut down political agitation, vested commercial interests went scot-free.

The second season started with a crackdown on illegal currency traders and smugglers. The desperation to control the free fall of currency and the fear of un-anchoring inflation expectations pushed State organs to act with full force.

The actions appear to have been delivered in the short term. Illegal currency traders have gone underground and smuggling from Iran and Afghanistan borders has come to a halt for the time being. This has allowed the currency to self-correct in the open market.

The question is on the sustainability and durability of these actions. The State would be at loggerheads with deep rooted mafias which have strong inter-linkages to the traditional political parties, businesses, and elements within the State institutions (including border patrolling agencies), and bureaucracy. These vested interests will fight for their turf with every trick up their sleeves. The fight is not going to be easy, and the State may discover the limits of both its will and ability.

Smuggling of goods and hundi-hawala have been around forever. And these have kept on nurturing and growing in the last couple of decades. That has created a big chunk of black economy in parallel to the formal. And these forces have elements everywhere to safeguard their interests.

Ever since US’s exit from Afghanistan, dollar inflows from Afghanistan to Pakistan dried up. And thereafter, the trade with Afghanistan started in Pak Rupee.

Pakistan did buy a significant amount of coal and other products from Afghanistan while importers paid the Afghan exporters in Rupee. However, the Afghans prefer to convert these to USD (and other foreign currencies) in Peshawar and then these physical dollars are smuggled out of Pakistan. This is constantly putting pressure on Pak Rupee in the open market.

Then, smuggling of diesel from Iran and other petroleum problem have also been there forever. Yet these goods would usually not make their way across the boundaries of Hub district, staying mostly within Balochistan. However, in the last year or so, the quantum has jumped, and smuggling penetration expanded to Sindh and southern Punjab.

Apart from this, import restriction from SBP have opened the avenue of other petrochemicals and various other products smuggling from Iran too. All these payments have created pressure on hawala/hundi.

The government has clamped down on these smuggling routes for the time being. However, there is another problem of under-invoicing of imports from China, which has also persisted for too long. This should be addressed.

There is a huge gap between the official import numbers from China to Pakistan and what China reports in its exports to Pakistan. The gap is due to under-invoicing of imports. In this fashion part of the imports is financed by formal interbank market while the remaining is done by hundi-hawala system.

In all these informal trades (smuggling), the State loses its share of taxes, and the central bank loses formal dollars in the shape of remittances. The State must have a crackdown against these practices as well and introduce incentives to convert them to formal channels.

By correcting these, the flows will divert towards formal banking system – both imports and remittances will rise. Imports are still restricted in a way (as banks are required keep current accounts close to balance). The outcome would be higher remittances and easing extra pressure on the PKR.

The good news is that the caretaker government is reviving incentive for boosting formal remittances. The federal government pays subsidy through banks to exchange companies in the sender countries for not charging fee from the remitter under Pakistan remittances initiative (PRI).

The amount is 20 Saudi Riyal (or equivalent in other currencies) per transactions of over $100. The amount was not released till November 2022, and that disincentivized the exchange companies in sender countries. Meanwhile, local banks were not actively marketing in sending countries as well.

SBP has informed the banks that the pending amount will be released soon, and it is expected that the federal government will add more sweetener to the package. That will push the informal remittances to banking system at a time when open market rate has converged to the interbank. If the open market rate remains in control, the monthly remittances flow can reach close to $3 billion per month.

The catch is to control the smuggling and hawala/hundi. Here, the writ and willingness of the State will be tested in the coming weeks and months. This would bring stability to the currency market (though this may slowly depreciate in the interbank due to inflation and interest rate differential).

The next step for the State should be to take businesses into confidence and ask them to pay taxes. Many businesspeople with cash are not buying dollars. They prefer to trade in commodities. With negative real rates, commodities beat inflation and match depreciation. However, they don’t pay income tax on capital gains. The State should catch them and ask them to pay tax. If they don’t, punish a few to set examples for others.

In this manner, the tax net must be expanded. Traders and retailers should be taken into confidence and incentivized to pay taxes at lower rates. The scope of documentation exercise must also be expanded to the real estate players, doctors, lawyers and other consulting professionals who do not pay their fair share of taxes.

The government may have to give some form of amnesty in the process, and that may hold true for informal cash dollar holders. However, there would be two challenges (apart from dealing with the mafias within). One is getting the IMF’s nod, and the other is the mandate and time caretakers have on their hands. More on that later.

Copyright Business Recorder, 2023