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Having a formal system against an informal system

Monetary remittances play a significant role in alleviating poverty as Remittance inflows can contribute significantly to a country’s economic well-being. Pakistan’s remittance inflows help in not just economic growth but also in improving social conditions. It serves as a catalyst for investment in the country, which in turn induces a cycle of growth-promoting production, exports, consumption, income, and further investment in turn.

Factors to boast remittances

The important factors to consider when transferring money are the speed of transfer, the strength of connectivity of the network through which the funds are transferred, the reliability of the remittance service provider, and the versatility of modes of transfer. The general inability of most money transfer services to satisfy these criteria plays a role in reducing remittance inflows in the country.

Across the remittance industry, high transaction costs hinder inflow and outflow. United Nations has set a target to reduce service fees that average 7% at present to 3% by 2030.

Pakistan Remittance Initiative (PRI)

In order to provide ownership structure in Pakistan for remittance facilitation, Ministry of Finance, State Bank of Pakistan and Ministry of Overseas Pakistanis launched Pakistan Remittance Initiative (PRI) in 2009.

Before the inception of PRI, only fewer banks and exchange companies were mobilizing home remittances in the absence of any centralized ownership structure with inefficient payment mechanism.

The major objective of PRI is to facilitate and ensure faster, cheaper, convenient and efficient flow of remittances in the country. PRI is sole responsible for entire home remittance ecosystem of Pakistan that mainly comprises of strategy, policy and implementation framework with commercial banks, microfinance banks, branchless banking operators and exchange companies in Pakistan. PRI analyzed the dynamics of remittance market to formulate a comprehensive strategy aimed at greater commitment of financial sector towards remittance services and resultant inculcation of remittance culture, transparency of remittance market with adequate consumer protection, efficiency of payment system infrastructure, and incentives for the remitters, beneficiaries and financial institutions. Presently, remittance distribution network consists of 24 banks, 5 microfinance banks and 17 exchange companies.

The domestic outreach

The national level outreach has been increasing through inclusion of new domestic financial institutions in home remittance business that include commercial banks, Microfinance banks, exchange companies and in the recent years Islamic banks. In order to further enhance outreach, Branchless Banking Operators (BBOs) had been allowed to disburse remittance payments received through Mobile Wallets. Presently, 12 BBOs are operating in the country with over 400,000 branchless banking agents.

Current status of remittances

Remittances remained above the $2 billion mark in December 2020 for the seventh month in a row. In the first half of 2020-21, inflows totaled $14.2 billion. The amount was about 25 per cent higher than $11.37 billion received in July-Dec 2019, up 43 per cent up from a year earlier.

According to the State Bank of Pakistan (SBP), a large part of the remittances during the July to March period in FY21 came mainly from Saudi Arabia, standing at $5.7 billion; the United Arab Emirates, at $4.5 billion; with $2.9 billion from Britain and $1.9 billion from the United States.

Spectacular rise of remittances

There would be several reasons to justify it. Pakistanis coming back from host countries after losing jobs are bringing back their savings; they are sending more money back home to provide greater financial support to families as Pakistan’s domestic economic growth turned negative; an effective crackdown on illegal transfers of foreign exchange has pushed up official inflows; and the central bank’s scheme to attract remittances through Roshan Digital Accounts for overseas Pakistanis has started showing the impact.

Will remittances continue to grow?

It is high time to separate the one-off factors of remittances’ growth and focus on structural changes made in the remittances’ regime that have so far kept them growing.This also requires inputs from the local dispersion. Banks are now reporting to the SBP greater details of remittances to help central bankers assess the patterns of growth and the SBP has launched an online survey seeking input from expatriate Pakistanis.

Pakistan needs to maintain the current level of $2bn monthly remittances and gradually take it to the next level of$30 billion a year.

The role of regulatory authorities

The stricter scrutiny by the SBP and the FIA of foreign exchange companies has so far helped a great deal in squeezing room for the Pakistani diaspora for sending foreign exchange via illegal channels of hundi or hawala. The sustainable growth in remittances could not be possible without maintaining growth in manpower exports. The total number of Pakistani working aboard are 11.4 million. Out of these less than 50% are highly qualified, highly skilled and skilled people; whereas more than 50% are semi-skilled and unskilled workers. If a reasonable portion of remittances goes towards savings and investment, it would be more helpful and reduce our dependence on external borrowings.

The remittance growth rate in Bangladesh is even swifter than in Pakistan, which shows greater use of informal channels and travel by that country’s overseas workers’ sending money to families at home. Besides, remittances are growing rapidly from the US and Europe where travel restrictions are stricter.

The informal channels

Hawala and Hundi are two of the most familiar terms in Pakistan’s economic landscape. These are identical with informal channels through which money flows in or out of the country. It has been on the policymakers’ radar for a long time but there has not been any significant success in terms of curbing its workings. Hawala basically denotes a system made up of money lenders and businessmen around the globe. What distinguishes it from the formal exchange channels (like banking) is that it works largely on repute and trust rather than formal contracts. It comes with its advantages, anonymity being the primary one. The other primary advantage comes in the form of avoiding expensive formal channels of finance and exchange. Anonymity, however, comes with a heavy price tag for countries like Pakistan as this particular characteristic has been mercilessly exploited by smugglers, drug peddlers and terrorism financiers. Consumers are usually saved that predicament in an informal, decentralized system like Hawala. Once a reputation of operator is tarred, its curtains for that business and no amount of running around can recoup the lost repute. More importantly, there is little possibility of ‘too big to fail’ phenomenon, to be bailed out using taxpayer money. Thus society not only benefits in terms of saving money (very low transaction fees), but also in terms of a decentralized system that weeds out inefficient, unproductive and corrupt operators without the need for a central authority or courts.

How to curb down illegal banking

Pakistan should sharpen its focus on the money exchange and transfer companies, especially hawala or hundi money transfer businesses that work under a system that allows customers to rapidly move large sums across borders outside the scrutiny of regulators.

Another crucial factor is related to the measures adopted by the government and the central bank to block illegal and informal money transfers into and out of the country to comply with FATF conditions in order to exit the task force’s grey list.

In order to curb hawala type system needs an understanding of the nature and forces that propel it. If informal systems of financial transactions have endured for centuries, there are good reasons for that, some of them outlined above. A society and its inhabitants have the capacity to compare transaction costs of having a formal system against an informal system. If the former confers a lower cost, the latter would disappear without the need for state intervention (and vice versa). If this point can be grasped, then it is clear that Pakistan’s policymakers should first review the predatory nature of its functioning (specifically its taxation) plus that of its financial system, and what cost it inflicts upon the society.

The author, Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes articles on diversified topics. Mr. Shaikh could be reached at [email protected]

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