How to sustain export expansion?

In recent past, exports went up for one or two quarters and years before stagnating

ISLAMABAD:

The first half of current fiscal year has seen a 4.98% year-on-year growth in exports. Month-wise data shows that exports in October, November and December grew 4.2%, 8.3% and 18% year-on-year respectively.

Taking into account the Covid-induced upheavals, this is a creditable performance. The major challenge, however, is to sustain the increase in exports. In the recent past on quite a few occasions, exports went up for one or two quarters and years before stagnating.

Rather than being an isolated variable, exports are a function of the entire economy. Sustained export growth presupposes a stable macroeconomic environment, particularly low inflation and exchange rate stability. Although a moderate price increase is a necessary inducement for businesses to invest, high and persistent increase in prices drives up the cost of production and tends to make domestic products less competitive in foreign markets.

Inflation remained in double digits during the last fiscal year, with the year closing at average Consumer Price Index (CPI) and Wholesale Price Index (WPI) of 10.7% and 10.2% respectively. In the first six months of current fiscal year, both the CPI and WPI have been in single digit. As per State Bank of Pakistan’s (SBP) projections, FY21 will close with average CPI inflation in the range of 7-9%, exceeding the budgetary target of 6.5%, which would build up inflationary pressures in the economy.

The exchange rate should exhibit two basic characteristics – it should not be volatile and its value should stay close to the long-run equilibrium exchange rate, ie, the rate at which supply and demand for different currencies are equal. Like most other countries, Pakistan follows a floating exchange rate system, where although the government or the central bank doesn’t fix the exchange rate, it intervenes in the forex market from time to time to keep it close to the desired level. Due to these interventions, the exchange rate tends to be either overvalued or undervalued.

An undervalued exchange rate makes exports cheaper and contributes to their increase provided they are price elastic, ie, they respond positively to price changes. However, a grossly undervalued exchange rate will stoke inflation and thus may discourage exports.

In contrast, an overvalued exchange rate makes exports expensive. If a country’s products compete in foreign markets on the basis of price rather than quality or brand loyalty, as in the case of Pakistan, an overvalued currency can be a strong drag on exports.

Manufacturing growth

Sustained growth of value-added manufacturing is essential for export growth. In the last five years (FY16-20), the manufacturing sector registered average growth of 1.7% only. In FY19 and FY20, the manufacturing registered a negative growth of 0.7% and 5.6% respectively.

Large-scale manufacturing (LSM), which accounts for more than 70% of the total manufacturing output, grew nominally by 0.9% on average over the past half a decade including negative growth of 2.6% and 7.8% in FY19 and FY20 respectively.

The 7.4% expansion in LSM in the first five months of current fiscal year is welcome but it remains to be seen whether it is a one-off growth.

Manufacturing constituted only 13.2% of gross domestic product (GDP) in FY19 and 12.5% in FY20. Thus, Pakistan is facing a double whammy of shrinking share of manufacturing relative to the total output – premature deindustrialisation – as well as recession in its growth. A net oil and food importing country like Pakistan can’t hope to lift its merchandise exports in the face of a disappointing performance of its manufacturing sector.

The premature deindustrialisation started in the 1990s when Pakistan unilaterally slashed import tariffs as part of the International Monetary Fund (IMF)-sponsored structural adjustment programmes without preparing the domestic industry to face the ensuing increased competition with foreign products.

As examples from several other developing economies show, trade liberalisation without making the domestic industry competitive is an ill-advised strategy.

To revive manufacturing or industrialisation, two basic things need to be done. First, the share of total investment in GDP must increase.

Pakistan has one of the lowest investment-to-GDP ratios in the world. At the end of FY20, the share of investment in GDP was only 15.4%, marginally down from 15.6% in FY19.

The source of investment in a country is savings, which have two components – domestic and foreign.

In FY20, the share of savings in GDP was 13.9%, in which the share of domestic and foreign savings was 6.8% and 7.1% respectively. This means that less than 7% of the total output or national income is being saved. This makes the country overly dependent on foreign capital inflows for investment.

In fact, domestic savings is one of the most neglected areas in the economy. Both cultural, such as a high propensity to consume and conspicuous consumption, and economic, such as low incomes and lack of attractive packages for small savers, factors underlie the low savings.

Once the share of domestic savings and thus the investment in GDP increases, the government through taxation and other incentives should encourage that most of the savings are used for real sector investment rather than for speculative ventures, which have quicker yields but are a drag on economic expansion. Increased business confidence in the economy is also important for encouraging businesses to undertake long-term investment.

Foreign direct investment (FDI) is the most credible way to fill the gap between domestic savings and the desired level of investment.

Over the years, Pakistan has received low FDI inflows. Besides, FDI has been concentrated heavily in non-manufacturing sectors, such as telecommunications, finance and energy. As per Board of Investment (BOI) data, between FY15 and FY19, Pakistan received total FDI inflows of $12.54 billion, out of which energy, finance, ICT and construction sectors together accounted for $9.32 billion (74% of the total).

The share of manufacturing sub-sectors such as textile, electronics and non-electrical machinery in the total FDI was $206 million (1.6%), $264 million (2.1%) and $196 million (1.5%) respectively.

Pakistan has faced chronic energy shortage and lacks efficient energy infrastructure, which has adversely affected both consumers and businesses. FDI in energy has helped ease power outages and thus reduce the cost of doing business.

However, greater investment in export-oriented manufacturing sub-sectors is necessary to enhance the size of the domestic pie and provide a solid basis for long-term increase in exports. Macroeconomic stability, preferential incentive package for investment in export-oriented sectors and strong contract enforcement can be instrumental in attracting more FDI.

Since Pakistan’s two largest industries — textile and food processing — are agro-based, greater farm productivity is necessary for sustained increase in exports. In the past five years, the agriculture sector has grown on average by 1.9% including a 0.9% contraction in major crops. This is despite the fact that the total crop area has almost remained the same, ie 23.5 million hectares during this period.

From time to time, the economy faces wheat and cotton shortage. Cotton output went down from 13.96 million bales in FY15 to 9.2 million bales in FY20. In any case, the cotton grown is deficient in high quality, forcing exporting enterprises to rely on imported cotton. The dismal performance of agriculture, particularly the farm sector, is mainly due to low productivity of land. Pakistan is a labour abundant but skill deficient economy, which restricts industrial, and by implication export, expansion.

Private sector, which is the mainstay of the economy, by and large competes on the basis of low wages rather than high productivity, thus becoming a contestant in the race to the bottom. A comprehensive skill development ecosystem needs to be put in place. Through public-private partnership and demand-based vocational education, the skills of the 65 million-plus labour force can be upgraded. If any area warrants government subsidies to the private sector, it is skill development of workers.

The writer is an Islamabad-based columnist

 

Published in The Express Tribune, January 18^th, 2021.

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