‘Diaspora economics’
By Shahid Javed Burki
Monday, 28 Feb, 2011
IN spite of the near melt-down of the economy, the level of Pakistan’s foreign exchange reserves remains high, reaching record levels in recent weeks. This has happened as fiscal deficit continues to increase.
Economic theory tells us that as the government runs up its deficit, it impacts the external account. The relationship is simple. A higher deficit is usually financed – if not fully then at least in part – by borrowing from the central bank. The bank prints money to provide for the government’s needs and therefore adds to money supply. With the printing of money aggregate demand increases, some of which is satisfied by increased imports. This creates a gap between import expenditure and export earnings. The gap is financed by using accumulated reserves. We know that Islamabad is running a large deficit on the fiscal account. The deficit continues to climb and is expected to reach eight to 8.5 per cent of the gross domestic product by the time the current fiscal year runs its course. That will be on June 30. And yet no pressure is being felt on the external side. As the accompanying table shows, the level of reserves continues to rise, reaching $17.45 billion by February 12.
On a yearly basis, the current levels of reserves is the highest in the last 12 years, increasing from $2.3 billion in 1998-99 to eight times as much a dozen years later. The amounts received from the International Monetary Fund have certainly contributed to this increase. Pakistan signed a stand-by arrangement (SBA) with the Fund in late 2009 which was ultimately set at well over $11 billion. More than $7 billion of this amount has been disbursed. Even if this entire amount is factored out, the reserves still remain high.
One explanation for this development is that Pakistan has benefited from an extraordinary increase in the amount of remittances sent by its people living and working abroad. According to the latest data provided by the State Bank, remittances received increased by 17.7 per cent in the seven month period between July 2010 and January 2011, reaching $6.12 billion compared to $5.2 billion in the same period last year.
There are five main sources of remittances; together the UAE, Saudi Arabia, the United States, the GCC states, and Britain account for more than 87 per cent of the total. That was to be expected since the bulk of the Pakistani population working abroad lives in these five places. But there have been changes in the ordering of these sources of flows. At one point Saudi Arabia was the most important source. It was replaced by United States for a while. Now the largest source is UAE.
In some of my earlier works on the Pakistani economy I looked in some detail at what I called “diaspora economics”. We know that diasporas follow a four-phase life cycle. Initially people who settle in new lands spend the bulk of their savings in establishing themselves economically. Once this is done they begin to send money to help families and friends back home. The third phase entails giving for organised charities – the various foundations that have established entities abroad for raising funds for their operations. The fourth phase involves making investments in the home country. The diaspo ras from Pakistan are now old and mature enough to be in their third and fourth phases. The amounts of money that can be sent home are dependent on the economic situation of the remitters.
There was an expectation that the Great Recession of 2008-09 would affect the amount of remittances since there must have been the same kind of pressure on these populations as was felt by the populations at large. That did not happen. What could be the reason? The State Bank provides one answer to the question. “It may be pointed out that the State Bank, ministry of finance, and ministry of overseas Pakistanis had undertaken a joint initiative called ‘Pakistan Remittances Initiative’ (PRI) with a view to facilitating the flow of remittances through formal channels,” says the bank in a recent report. “This initiative has started to materialise and remittances through formal channels are showing considerable growth.” While channeling remittances away from such informal transmissions as those undertaken by hawala and hundi systems may have played a part, this effort began soon after the regulatory changes adopted by the United States Treasury in the post-9/11 world. It is unlikely that the impact of these requirements continues even ten years after the regulatory system was developed. Meekal Ahmad who has written extensively on the Pakistani economic issues has speculated that the whitening of black money may have much to do with the continuing increase in the level of remittances. He explains that Section 114 (4) of the Income Tax Act of 2001allows any capital inflow into Pakistan to be recorded as “workers’ re mittances” on the payment of a small fee. Once thus recorded it becomes free of tax. This provision in the tax code runs counter to the intention of another law – the AntiMoney Laundering Law – passed during the Musharraf period as a result of the US pressure.
His interpretation is worth examination especially when there have been such large increases in the amounts of remittances coming in from UAE. Ahmed believes that in the effort to escape the tax net a significant amount of capital has left the country and comes back as remittances and goes untaxed. There is some substance in this argument. Pakistani capitalists have also made undeclared investments abroad, in particular in the Middle East. It is known that Pakistanis participated in the real estate boom in UAE – in particular in Dubai – and the residential properties they bought were rented out. The rents came into Pakistan as remittances. Under the tax law, even incomes earned abroad are taxable in Pakistan unless they fall in one of the categories on which tax is not levied. Remittances belong to this category.
One more explanation was provided to me recently by the senior executives of a large IT firm in Pakistan. They have studied the growth of their sector in the country and believe that a significant amount of the earnings from IT come from what they label as the “cottage industry”. There are, they believe, thousands of people – mostly women with basic computer skills – who do simple jobs for their friends and relatives living abroad. Preparation of web sites or maintenance of accounts are two such tasks that can be performed from the kitchen table. The compensation for this type of activity comes in the form of remittances.
While the flow of remittances has become an important part of the Pakistani economy and is now an important source of foreign exchange earnings for the country, it is not well understood exactly what kind of flow this actually is. It is important to understand what is happening in this area.
This knowledge is essential for the design of tax policies and also for developing the IT sector. Studying remittances, therefore, is good for the making of public policy.