Import substitution: the big ticket item

KARACHI:

Pakistani rupee’s slide to Rs228 per US dollar has deepened the economic anxiety and sent shockwaves through the country.

The rupee’s fall will push up costs for the industries like auto parts and pharmaceuticals higher that rely on imported raw material. That’s going to feed inflation and ultimately the general public will have to bear the brunt.

Moreover, the surge in current account deficit and limited access to external funds has been draining the country’s foreign exchange reserves. The foreign currency reserves held by the State Bank were $9.3 billion for the week ended July 15, down from $17.8 billion at the end of July 2021, data released by the SBP shows.

This translates into a low level of import cover for just 1.6 months. In the meantime, the country’s current account deficit for the July-May period of FY22 ballooned to $15.2 billion, showing an increase of $14 billion, according to the SBP.

The skyrocketing current account deficit, which is arguably one of the biggest problems Pakistan is facing right now, is due to the increase in the trade deficit. Pakistan has seen a massive rise in imports in the past fiscal year, which has easily outpaced
export growth.

In the previous financial year that ended last month, Pakistan’s exports increased by 27% to $31.8 billion, as per the latest report of the Pakistan Bureau of Statistics (PBS). But imports climbed by 42% to $80.2 billion. As a result, the country ended FY22 with a trade deficit of $48.38 billion, up from $31 billion a year earlier. This 56% jump in deficit has weighed heavily on Pakistan’s current account balance, forex reserves and
rupee’s valuation.

The key to economic stability lies in fixing the trade balance by curbing imports and pushing up exports. The government has taken steps to do that, including banning imports of a variety of non‑essential luxury goods.

The protectionist policies might give some relief in the short term but they may eventually backfire since they can have an adverse impact on economic activity.

Instead of banning imports, the government should rather concentrate on encouraging investment, including FDI, to drive growth and expansion in the import-substitution industries.

An increase in domestic production of those goods which Pakistan typically gets from abroad will enable the country to curb imports in a sustainable manner.

A closer look at the PBS data reveals that the energy sector, particularly the oil refining industry, is one area where authorities need to concentrate in terms of ensuring growth and investment. Note that the massive trade deficit was driven in large part by the surge in energy imports, both in terms of quantity and price.

The country spent a staggering $12 billion on buying petroleum products like petrol and diesel in FY22, up more than 166% from $5.16 billion a year earlier.

During the year, fuel prices surged while consumption also increased, with the quantity of petroleum product imports rising by 28% to 18 million tons.

Pakistan can cut down this import bill significantly by encouraging investment and expansion of oil refineries. That’s because the oil refiners process crude oil to produce fuels like petrol, diesel, and jet fuel.

If the local refineries produce enough quantities of fuels, then there would be no need to spend billions of dollars on buying expensive refined products from abroad. Pakistan would, instead, be importing comparatively cheaper crude oil to feed its refineries.

There are five major oil refining companies in Pakistan that can process up to 449,000 barrels of oil per day. Unfortunately, the refiners have experienced some issues, which have prevented them from producing as much petrol and diesel as they actually can.

The main problem has been the decline in consumption of furnace oil after the power-producing companies started running their plants on LNG instead of furnace oil. LNG prices, however, have now gone through the roof.

On top of it, Pakistan also frequently experiences LNG cargo cancellations. To reduce reliance on LNG, the government should work together with the power companies and ensure some of the power plants always run
on furnace oil.

This will also greatly help the refiners, allowing them to operate their facilities at maximum capacity.

If the domestic refiners were to fully utilise their plants, then this could translate into forex savings of hundreds of millions of dollars, or more than a billion dollars each year, considering the high refining margin – especially on diesel – that goes out to foreign companies in case of imports.

To encourage expansion and modernisation among oil refineries, the authorities must also introduce business-friendly policies. Currently, there is no policy framework that could encourage the refineries to spend on growing and upgrading their plants.

Fortunately, the previous government, after consulting with the stakeholders, prepared a draft of a refinery policy to grow and modernise this industry. That policy should be brought forward so that refiners have an incentive to increase their capacities and improve their crude
processing capabilities.

By expanding the refining capacity and ramping up domestic production of diesel and petrol, Pakistan can cut down imports and meaningfully strengthen its current account balance. Besides oil refining, the policymakers must also consider other areas that offer import substitution opportunities, particularly in industries where output can be scaled up quickly.

A closer look should be taken at air conditioning, kitchenware, cosmetics, toys, sanitary fixtures, and other industries. Some of these may not seem like big ticket items, especially when compared to oil refining, but together, they can help save Pakistan significant foreign exchange and put the country on a firmer
financial footing.

The writer focuses on subjects of business and economics, specialising in the energy sector

 

Published in The Express Tribune, July 25^th, 2022.

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