Last month, the State Bank of Pakistan discontinued the reporting of ‘FE-25 Deposits and their Utilization’ statistics, which reported the month-end position of foreign currency deposits held with all scheduled banks, and the deployment of those FX deposits for trade finance services extended to borrowers. Coincidentally, the discontinuation of this dataset has taken place at a time when dollar-based financing is nearing its 10-year peak (also, its 20-year peak!).

In June 2024, FE-25-based trade finance (dollar-denominated import and export loans) breached the two-billion-dollar mark, levels only seen twice before in history. Dollar-denominated trade finance has doubled over the last three years, coinciding with the peak of monetary tightening and historic contraction in private sector credit growth.

Although precise statistics on FE-deposits utilization and dollar-denominated lending would no longer be available, broad trends may be gleaned from other datasets released by the central bank from time to time, with editorial caution of allowing some room for error and misinterpretation.

For most readers who follow money and forex markets closely, the dramatic rise in dollar-denominated trade finance, especially over the last financial year, might not be big news. FE-loans marked their fastest growth beginning Q4-FY23, when the confidence in macroeconomic stability had collapsed prior to the signing of the Standby Arrangement with the IMF at the end of June 2023. At the time, commercial banks had been told to manage their FX requirements for trade transactions internally or the interbank market, rather than looking toward the central bank reserves. Although the near-term currency outlook was not yet stable, dollar-based financing was the only avenue available to borrowers looking to finance their trade requirements, with the bulk of demand at the time coming from importing firms.

Soon after, however, FE-based import financing peaked at $1.5 billion by June 2023 (although it has averaged $1.4 billion dollars over the last 12 months). Instead, beginning September 2023, dollar-based FE loans picked pace and doubled between Jul and Oct 2023 – from $203 million to $438 million. As of Aug 2024 – as of the last month of reporting – export-based FE loans are at nine- nine-and-a-half-year peak of $581 million.

As the datasets will no longer be available, we will never know for sure whether dollar-based export lending marched forward, or peaked out. The obvious explanation for the extraordinary rise in export loans was stability in the near-term currency outlook and the massive interest rate differential between Kibor and SOFR. And that trend is best explained by looking closely at the greatest beneficiary of dollar-denominated export loans: the textiles and apparel industry.

Between Dec-2020 and Aug-2024, the share of dollar-based financing in total working capital lending to the textiles and apparel industries rose from just 16 percent to 26 percent. In fact, dollar-based financing now constitutes half of total export loans availed by the textiles and apparel industry, compared to four years ago when its share stood a little over 25 percent.

But working capital borrowing by the textile and apparel industry has been flat-lined for the past two years (in Rupee terms), you must ask? In fact, it has declined by more than two billion dollars compared to its Dec 2021 peak, when aggregate ST credit to the textile and apparel industry stood at $7.3 billion. So why did dollar-based export loans rise during the same period? And is it any cause for celebration?

Yes, maybe. Dollar-based export loans rose at a time when the Rupee Rupee-based credit market had frozen with the rising of the policy rate to its highest-ever level of 22 percent. This also coincided with the de-capping of markup rates on export-based concessional finance available to the textile industry, with the EFS rate also rising to record levels of 20 percent (or policy rate minus 200bps). In contrast, the SOFR-pegged dollar loans offered potential borrowers a positive credit spread of 10 to 15 percentage points, provided three conditions were met: i) a stable currency outlook, ii) settlement with export receipts, but most importantly, iii) commercial banks’ willingness to take dollar-exposure on the potential borrower.

Granted, that on a net basis, the interest rate premia on foreign currency trade finance may have been exploited by borrowers to refinance expensive Rupee-based working capital liquidity requirement. But it is worth remembering a few significant differences.

First, the FE loans are commercially priced, meaning in many cases, they were replacing working capital loans previously obtained on concessional pricing (or under the EFS facility). Two, as dollar-denominated export loans, FE financing can only be knocked off (or settled) against solid export receipts, and not by buying foreign exchange from the currency market on the due date. That means guaranteed exports, and better visibility for the lending institutions on future foreign exchange inflows (by matching the tenor of the loan). And three, and most importantly, unlike EFS or other PKR-based working capital loans, FE export loans have a natural tendency to shorten the credit turnover period.

How? Bear in mind that while all trade-based financing is usually available for up to 180 days, in the case of pre-shipment Export Refinance (or EFS), exporters have the right to effectively roll over that loan on (or after) the date of shipment, by discounting the export bill (and avoid any penalty for as long as it can show export performance at the end of financial year). Moreover, EFS loans can also be settled through their own sources or other means of financing such as Running Finance or credit lines, provided Kibor based markup rate is feasible.

In contrast, dollar-based pre-shipment loans can only be settled by actual export receipts. Granted that while these loans are also available for a maximum period of 180 days, both the borrower and the lender have diminished willingness to neither extend nor avail FE loans for maximum tenor, as it also exacerbates the currency risk. Thus, the average aging or maturity of FE loans does not usually extend beyond a 90-day period.

Now look closely at various sub-segments of the textile and apparel industry. The percentage share of dollar-based financing in total ST borrowing increased by double digits for all sub-segments of the industry. Surprisingly, the most dramatic improvement was recorded by the made-up articles (bedding, towels, etc) the segment where the share of dollar-based loans rose from 18 percent in Dec-20 (at the height of the concessional finance bonanza) to 40 percent. Not surprisingly, the spinning segment was the weakest performer, where the share of dollar-based financing rose from 16 to just 21 percent. But shockingly, the readymade garments segment underperformed, with a share of dollar-based loans rising from 20 to just 27 percent.

Higher dollar-based export loans need not necessarily mean higher growth in exports. It does not even mean more working capital borrowing or improved liquidity for the borrower. However, at a firm level, it may indicate improvement in credit allocation, with only the strongest of performers willing to take dollar-based exposure, at a time when macroeconomic direction had tanked. It also indicates better churn of working capital, and the slow but sure weaning away of the exporting industry from concessional-priced loans, which is definitely another positive.

Is the era of peak dollar-based export financing behind us? Unfortunately, we will never know for sure.