Foreign Currency Deposits and International Liquidity Shortages in Pakistan

IMF Working Papers, September 1, 2004

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This paper studies the implications of foreign currency deposits (FCDs) for international liquidity shortages in Pakistan.
The analysis focuses on how the large volume of FCDs and the specific institutional characteristics of those deposits have made the Pakistan economy highly vulnerable to exogenous shocks.
The analysis shows that FCDs created another channel for government borrowing, and fiscal sustainability in a "closed" system may be very different from sustainability in a more "open" system.
There is a need to think of these issues in terms of total balance sheet vulnerability, and the authors recommend measures that would make domestic-currency-denominated assets attractive to investors.
Disclaimer: This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Large volume of foreign currency deposits (FCDs) increased vulnerability to exogenous shocks in Pakistan.
Institutional characteristics of FCDs altered the transmission of international liquidity shortages into domestic financial conditions.
FCDs created another channel for government borrowing.
Fiscal sustainability assessments differ between a "closed" system and a more "open" system when FCDs and related balance sheet effects are considered.
Emphasis on assessing total balance sheet vulnerability rather than focusing solely on traditional fiscal or external metrics.

Implement measures to make domestic-currency-denominated assets attractive to investors to reduce reliance on FCDs.
Consider the implications of FCDs as a government borrowing channel when designing fiscal and financial policies.
Assess and manage total balance sheet vulnerability across public and private sectors to mitigate risks from international liquidity shortages.

Subjects: Asset and liability management, Bank deposits, Central banks, Commercial banks, Financial institutions, Financial services, Foreign exchange, International liquidity, International reserves
Keywords: balance of payments, Bank deposits, capital account, Capital Account Liberalization, Commercial banks, credit rationing, current account, Dollarization, FCD deposit, FCD scheme, Financial Development, foreign currency, International liquidity, International reserves, private sector, risk premium, state bank, WP