KARACHI: One of the most daunting economic challenges for the incoming government will be the record-breaking trade and current account deficits.
According to the external trade statistics reported by the Pakistan Bureau of Statistics (PBS), the trade deficit in FY18 widened to $37.65 billion whereas the State Bank of Pakistan (SBP) reported that the current account deficit swelled to $18 billion. In comparison, the current account deficit was at $2.5 billion in FY13.
The SBP has suggested that the deficit has soared to unsustainable levels, primarily due to increasing aggregate demand. Therefore, depreciation of the Pakistani rupee by more than 20% and the hike in policy rate by 175 basis points since December 2017 were aimed at curtailing the rise in both deficits.
The real effective exchange rate fell more than 10 percentage points between November 2017 and May 2018 as the rupee moved towards its equilibrium value. Unfortunately, stop-gap measures may alleviate concerns for only a short period of time. Exports increased more than 13.7% in FY18. However, imports rose 15.04%. Therefore, the growth in imports exceeded that of exports.
Even though trade policies such as export subsidies, duty drawback and higher tariffs on non-essential goods have been adopted along with depreciation of the rupee to reduce the deficits, they have rather been ineffective. Total imports in FY18, reported by the PBS, at $60.9 billion is approximately 2.6 times greater than total exports of $23.2 billion. In order to reduce the trade deficit in FY19 over the amount reported in FY18, exports have to grow more than 2.6 times faster than imports.
The incoming government must not rely solely on short-term policies that have been frequently implemented to reduce the trade deficit. These policies not only tend to be ineffective, but their application can instead be counterproductive, particularly if benefits are available only to a few selected exporters. This is likely to reduce national welfare. The government must consider longer-term policies that improve overall competitiveness of Pakistani industries rather than repeatedly apply ineffective short-term measures.
Long-term measures may not provide immediate relief, but can induce industrial transformation for the benefit of Pakistani industries and reduce deficits to more sustainable levels.
According to information retrieved from the International Trade Centre’s (ITC) Trademap.org, imports into Pakistan from China grew 23% per annum between 2013 and 2017.
However, imports from the US, Indonesia and Thailand grew more than 12% per annum between 2013 and 2017. Imports from Qatar increased 83% per annum.
Although Pakistan may not be ranked as an important export destination for the aforementioned countries, the growth in value of exports from each of the trading partners is significant given that more than $1 billion worth of goods are exported to Pakistan from each of them. In essence, the growth in imports into Pakistan has been one of the highest in the world among countries reporting more than $40 billion in imports in 2017. However, unlike Vietnam where both exports and imports grew at higher rates, export growth failed to accompany the increase in imports into Pakistan.
More than 20% of imports into Pakistan in 2017 were of mineral fuels. Other major imports included machinery, iron and steel and vehicles.
Imports of machinery, mechanical appliances and vehicles increased 22% per annum between 2013 and 2017 while imports of electrical machinery and equipment as well as iron and steel rose 15%.
Total imports of mineral fuels declined 6%, but imports of liquefied natural gas (LNG) showed a whopping growth of 2,850% per annum between 2013 and 2017.
Pakistan also imports significant amounts of organic chemicals, palm oil and polymers of ethylene and propylene in primary form. These products are primarily used as inputs for industrial production.
It is essential to ensure promotion of manufacturing activities that increase value addition within Pakistan.
Product classifications based on their stage of inputs, as quoted by the World Bank’s World Integrated Trade Solution, show there had been a significant increase in imports of capital goods into Pakistan between 2013 and 2017.
Approximately 35% of all industrial goods imported into Pakistan were capital goods in 2017 compared to 21% in 2013. Majority of the capital goods imported were either communication devices or power-generating machinery and equipment.
However, the imports of capital goods, such as textile and other industrial machinery, to directly boost manufacturing activities remain relatively muted.
SBP data on large-scale manufacturing suggests minimal growth in export-oriented industries between July 2017 and May 2018. For instance, textile industry reported growth of only 0.38% while production of leather industry decreased 10.36%. Production of food and beverages increased 6.15%.
On the other hand, the automobile, electronics and iron and steel industries reported growth of 18%, 36% and 22% respectively. Growth in the electronics industry has been driven by the increase in production of electric transformers and electric motors.
The production of several value-added electrical consumer goods instead fell.
In essence, export-oriented industries have struggled to grow. Although domestic manufacturing activities must be promoted, it is crucial that at a time when Pakistan needs to accumulate foreign reserves, industries with higher growth must become competitive in the global market to alleviate the trade deficit.
It is imperative that policies not only support higher growth for export-oriented industries, but also ensure that other industries participate in global value chains.
In conclusion, the incoming government will face an uphill battle to alleviate the increasing trade and current account deficits. Policymakers will have to ensure that they not only increase exports of value-added products, but also attract foreign investment as well as develop and promote all avenues that accumulate much-needed foreign reserves. A holistic approach is needed so that political and economic environment becomes conducive for industrial and commercial growth.
The writer is Assistant Professor of Economics and Research Fellow at CBER, IBA
Published in The Express Tribune, August 6th, 2018.