Refinancing of exports: enough celebration! – Opinion
The textile industry has been the largest recipient of government concessions and subsidies throughout most of Pakistan’s history. It’s time for the industry to wear big boys’ pants. The industry has mastered the art of wresting concessions from government, regardless of which party is in power. Two thirds of SBP (National Bank of Pakistan) concessional refinancing programs in the form of short and long term loans are owed by textile players.
Of the Rs 647 billion of the export refinancing program (ERF), the share of textiles is Rs 429 billion. This is for the working capital requirement. In the case of long-term industrial expansion loan programs (LTFF / TERF), textiles brought in 327 billion rupees (out of a total of 493 billion rupees). There are opportunity costs for other industries and direct costs for the central bank in granting these concessions. The government and SBP must rethink the strategy.
This article explores ERF. The program started a few decades ago. At that time, the working capital requirement was 180 days and refinancing was provided to exporters for half of the annual export amounts. This involves renewing the loan twice a year. The goal is to buy the raw material and incur other running expenses until the time the buyer pays.
Over time, the working capital cycle has narrowed and the supply of FER to many exporters exceeds what they need. If the ERF had been provided at market rates, this would not have been a problem as the borrower would have limited their exposure as needed. However, the ERF rate is only a fraction of market rates; there are arbitrage opportunities for smart borrowers. And the textile boys are smart enough to extract any economic rent that comes their way.
There are two types of arbitration. One is to take the low rate ERF and invest (park) the excess at market rates. The same goes for the LTFF in the past. Some speculate that in the 2000s, some textile players became real estate moguls by using (or abusing) concession regimes offered to them to boost exports.
Witness to this practice, after 2008, the IMF (International Monetary Fund) asked the government to link the ERF to market rates. The ERF rate was increased to 10% in 2011 and in 2013 the interest rate difference (between the ERF rate and the 3M KIBOR rate) was around 1%. The gap has narrowed enough to kill the arbitrage. Then in the PML-N time, the ERF rate fell further with the reduction in the discount rate. In 2016, the maximum ERF rate was 3%. The current SBP regime has kept the interest rate frozen, even though the policy rate has fallen from 13% to 7% and is now on the rise. Banks lend to exporters at a maximum of 3% while the SBP refinances bank financing at 2%. The banks spread is up to 1%.
The rationale for Dar’s ERF rate cut was to compensate textile players for the currency’s disadvantage. The currency was kept artificially overvalued and exporters lost their competitive edge. Dar reduced to ERF rates as a balance. Moreover, the market rates were also low and this was another good reason to lower the ERF rate proportionately. The interest rate differential was around 3% in 2016 and 2017. However, the PML-N under Dar did not extend the limits of the FER too much.
The situation has changed over the past three years. The country has a flexible exchange rate regime. Other forms of export subsidies are granted under the PTI regime. In addition, market rates have increased. The average interest rate differential has remained at 6.8% since January 2019. The textile boys are having fun. This is evidenced by the record profitability of listed companies.
The advantage is not limited to favorable rates (interest and exchange), a better reimbursement policy and comparable energy prices at the regional level. The limits of ERF have also widened. The ERF textile portfolio fell from 235 billion rupees ($ 1.7 billion) to 429 billion rupees ($ 2.5 billion). The increase is almost 50 percent in dollar terms. The high interest rate differential and higher allocation prompted textile players to invest an excess amount of ERF in risk-free government papers. Borrow at 3% and put excess cash in treasury bills at 9-10%.
The other punters are to hold dollars outside of Pakistan as long as they can earn on the depreciation of the currency. Exporters (until last week) were allowed to keep export earnings outside Pakistan for up to 180 days. They could borrow in PKR at 2-3% and at that price they could hold their USD exposure (keeping the commodities out) for 180 days to take advantage of the depreciation of the PKR. Any depreciation greater than 1.5% is free money. This factor is now exerting further downward pressure on PKR. This is why SBP last week reduced the limit to 120 days.
Reputable large integrated textile exporters say such arbitrage is not possible, as the majority of their customers are large retailers, and they return the money directly to Pakistan on agreed terms. They can’t hold back the dollars. However, they accept that certain players, who have their own companies registered in the buying country, and those who sell semi-finished products, benefit from this arbitration.
The caveat they have about reducing the dollar hold time is that they have a longer payment term agreed to with buyers, and now they have to change the terms. If the buyer does not agree, he may turn to sellers in other countries and Pakistan may lose its share. The fear could be true in the short term on existing contracts.
However, one big player frankly admits that all players in the textile industry are for profit maximization and whenever they have the opportunity to make money, they will not miss it. Since the allocation is to hold dollars for six months, the cost of borrowing is low, and the currency is expected to depreciate, major exporters are deliberately contracting for higher days. In doing so, they get better dollar prices, as buyers benefit from a longer credit period and can benefit from the depreciation of the currency. The other element is that exporters are not limited to using the RMF for working capital of exports; they put the excess allocation in treasury bills. He recommended that the government commit to exporters to only use the ERF for the purposes for which it is intended. According to him, the big players can also refrain from this arbitration.
SBP should remember to slowly tighten the ERF tab. Over the past three years, SBP has been too generous to exporters. It’s time to release the stimulus. But it should be done slowly because abrupt changes can hurt the growing momentum of exports. ERF rates should be rationalized first. This will encourage textile exporters to borrow in USD. Banks can lend in USD against their deposits in FE25 (foreign currency).
Some exporters say that since they are selling futures dollars, they cannot borrow in dollars. They sell futures because they borrow in PKR. They borrow in PKR because the rates are ridiculously low. If the rates go up, they can go get loans in USD and settle the loans once they get the export proceeds – the loan and the proceeds must be in USD. It would not be necessary to hedge by selling futures dollars. And it makes more sense to borrow in USD when the PKR rate is high. History suggests that when PKR interest rates are high and the interest rate differential (market rate and ERF) is small, export financing against FE25 increases.
Exporters follow the incentives. The government must offer them an environment comparable to those offered to their regional competitors. However, at the same time, too much inducement at one point could be counterproductive. SBP should strive to balance the structure of incentives. Pakistan’s export potential is $ 88 billion, three times the exports, according to a recent World Bank report. Concessional financing regimes have limited effectiveness. The focus should be on overall business productivity by having a more balanced incentive structure and wisely using the limited concessions available to a cash-strapped government.
Commercial copyright recorder, 2022