The news that Foreign Currency Deposits (FCDs) under FE-25 scheme are showing a rising trend is somewhat disturbing. According to the latest data from the State Bank, the outstanding amount under this scheme rose to 3481 million dollars by the end of May, 2006 as against 3105 million dollars a year earlier and 3282 million dollars at the end of June, 2005.
The surge was more pronounced in the last five months of the current fiscal year with outstanding balances averaging around 3498 million dollars compared with a similar average of 3327 million dollars in the first six months of the year.
These balances stood at their highest level of 3567 million dollars at the end of January, 2006 and lowest level of 3302 million dollars at the end of July 2005. Earlier, balances under FE-25 scheme had reached 2296 million dollars at the end of FY03 and 2671 million dollars a year later.
It may be recalled that these deposits have a strange history. The FE-25 scheme was introduced in the aftermath of Pakistan's nuclear explosions and the imposition of sanctions by most of the western countries leading to restrictions on withdrawals from foreign currency accounts existing as on May 28, 1998 and was meant specifically to allay fears of any future "freezing".
Separate registers were to be maintained by Authorised Dealers (ADs) for deposits under the new scheme. Also, since FE-25 deposits are outside the State Bank's forward cover scheme, these are not required to be surrendered to the central bank.
The ADs, who are free to decide the return on such deposits, are under no restriction to lend, invest and place these funds in Pakistan or abroad, subject to the observance of the prescribed regulations. As regards their actual utilisation as at the end of May, 2006, 1147 million dollars were used for financing foreign trade, 1529 million dollars were placed under various arrangements including those with SBP and 538 million dollars were held as balances abroad.
The increasing level of deposits under FE-25 scheme is, in our view, a matter of concern for several reasons. It shows that citizens of the country, residing in Pakistan or abroad, have a lower level of confidence in their own currency than foreign currencies.
This is sad but understandable. Clearly, they think that, over time, the loss in interest income by swapping the currencies will be more than compensated by the depreciation of the Pak rupee which is sure to follow because of inflation differential and the deteriorating trend in the external sector of the country.
The authorities need to stop the dollarisation of the economy by making appropriate interest and exchange rate adjustments and reducing the inflation rate in the country, which to a large extent is responsible for the debasement of the Pak currency. It is better to delve into the reasons of the emerging situation and find suitable policy responses.
The Steel Mill case, as it is unravelling now, could also have its own consequences, whatever the verdict of the Apex court. The privatisation efforts of the government could receive a serious setback, which, in turn, would have severe implications for privatisation proceeds, leading to worsening of fiscal deficit and further deterioration of current account balance of the country.
Of course, the foreign exchange reserves held by the State Bank would be the first line of defence to meet the external deficit but in a crisis situation, the authorities may be tempted to try other options including the remote possibility of the use of FE-25 deposits.
Those who argue that freezing of foreign currency accounts during 1998 was the result of explosion of nuclear devices and accompanying sanctions are wrong because the actual reason was that foreign exchange balances of the depositors were eleven times higher than the total reserves of the country and there was no way one could meet these liabilities.
It needs to be remembered that foreign currency deposits are not free reserves of the country but involve an equal amount of liabilities in foreign exchange to be paid on the demand of the depositors. Nobody is saying that such a situation is again around the corner or even on the horizon, but it is better to learn from past experience and be careful when the going is still not that tough.