What has caused Pakistan's alarming trade deficit?

Pakistan’s trade deficit has hit a record level of 30 billion US dollars in the first 11 months of 2016-17, showing a jump of 42 per cent as compared to the same period in the previous financial year. Exports have declined by three per cent to 18.5 billion US dollars while imports have gone up by 21 per cent to 48.5 billion US dollars.

Never before in the country’s history have imports been over two-and-a-half times of exports as they are now. This unprecedented trade deficit has occurred despite the prevalence of relatively low international prices of our biggest import, oil.

A number of questions arise about the size of this deficit. What factors explain the fall in exports and the phenomenal rise in imports? What are the macroeconomic implications of such a large trade deficit? What measures do we need to undertake urgently to address the deterioration in Pakistan’s international trade balance?

The government attributes the decline in exports to the stagnant volume of world trade and low commodity prices in global markets. But our exports have been falling since 2013-14 (after attaining the peak level of 25 billion US dollars a year earlier) much before world trade slowed down and commodity prices fell.

Additionally, non-oil commodity prices have partially recovered after falling towards the end of 2015 and the year 2016 has witnessed a 12 per cent increase in the value of global trade. Some other countries, such as Bangladesh and Vietnam, have performed well in this improved global trade environment.

The reasons why Pakistan’s exports have declined by 20 per cent since 2013-14 include a number of structural factors and wrong policies. Unlike East Asia, Pakistan has historically followed a policy of import substitution rather than export promotion.

Consequently, there has been little emphasis on broadening the export base that has remained over-reliant on textiles as the principal export. Even now, exports of cotton yarn, cloth and value-added textiles constitute almost 60 per cent of our total exports.

Exports of other items have taken a big hit in the last three years, the decrease in them ranging from two per cent to 22 per cent. Many of these exports are from the agricultural sector or by small and medium enterprises.

Unfortunately, these sectors have been neglected through overtaxation of inputs, lack of access to infrastructure, especially electricity and gas, and restricted availability of credit from commercial banks. Extraordinary skills of Pakistani craftspersons, therefore, have remained largely unrealised. In India, on the other hand, exports of precious stones and jewellery lone now earn more than twice the total export earnings of Pakistan.

Since 2014, our exports have floundered because they can no longer compete in the international market due to an overvalued rupee and the relatively high cost of inputs like electricity. We need to realise that the loss of buoyancy in world trade has led to a low-intensity trade war being waged through competitive devaluations of currencies.

Most Asian currencies have fallen by anywhere between eight per cent and 84 per cent. Pakistan, instead, has opted to maintain a relatively stable value of the rupee, with only five per cent nominal depreciation over the last year. In reality, the rupee has appreciated recently because of its link to the strengthening American dollar.

Explaining the rapid growth in imports in 2016-17, the government has stated that this is largely due to the upsurge in machinery imports, especially for projects related to the China-Pakistan Economic Corridor (CPEC).

Home remittances and money sent back by Pakistanis working abroad havefinanced the bulk of Pakistan’s trade deficit for the last many years

This is only partially true. Up to April, the rise in the CPEC linked imports accounted for 38 per cent of the total increase in imports. Other major contributors to the increase are food, petroleum, automobiles and other intermediate goods.

The government needs to appreciate that the burgeoning imports are not due to extraordinary growth of the economy, which continues to show a moderate growth rate of 4-5 per cent. The principal factor is the relative cheapness of imports due to our currency being overvalued by over 20 per cent.

Consequently, many import-substituting industries within Pakistan have been unable to compete and the volume of major imports has gone up by anywhere between 18 and 56 per cent for different items. Such big increases are unprecedented for many imports.

Home remittances and money sent back by Pakistanis working abroad have financed the bulk of Pakistan’s trade deficit for the last many years. In 2016-17, the substantial widening of the deficit and lack of growth in remittances together have decreased the extent of this financing to 50 per cent of the deficit.

The resulting gap in financing has increased our overall current account deficit, which will have to be financed through increased external borrowing as well as by dipping into our foreign exchange reserves (which have decreased already by over three billion US dollars in 2016-17).

If trade deficit is not contained then Pakistan could face a financial crisis over the next 18 months. This may necessitate a return to the International Monetary Fund (IMF) for help and will probably require a number of drastic prior actions, including a substantial devaluation of rupee. This is what happened when Pakistan sought the IMF’s assistance last time.

The government’s reluctance to use currency exchange rate to stimulate exports and simultaneously discourage imports has compelled it to resort to administrative measures like imposing cash margins and regulatory duties on imports. An export incentive package, announced in January 2017, also increased tax rebates on a number of exports but these measures have proven to be inadequate. Delay in the payment of rebates, in fact, is affecting the liquidity of exporters.

The government needs to recognise that export growth is essential not only for the sustainability of external debt but also to raise the economy’s growth rate to six per cent or more. To achieve that, a gradual depreciation of rupee is the right path to follow. This will also help Pakistan avoid a big cut in the currency price later, which may fuel inflation to possibly reach double-digit levels.

Simultaneously, the export incentive package needs to be substantially strengthened by extending it to more items and by offering bigger incentives for exports to emerging markets. One way to ensure timely disbursement of rebates is their payment through commercial banks rather than through the Federal Board of Revenue (FBR). These banks in turn can seek reimbursements from the State Bank of Pakistan.

Pakistan must also more actively exploit the openings created by the GSP+ status granted to us by the European Union as well as the opportunities offered by China-Pakistan Free Trade Agreement and the South Asia Free Trade Area (Safta) agreement. New markets need to be developed especially in Central Asia, Iran and Turkey.

In the case of imports, imposition of regulatory duties could lead to under-invoicing. A more effective policy to cut imports could be to introduce a regime of minimum import price on a number of items, as has been done in the case of sugar. Also, import tariff could be doubled if a particular commodity is imported by more than a pre-specified level. This will also help in avoiding speculation by importers in the presence of an overvalued exchange rate and very low interest rates.

Pakistan needs to secure its balance of payments position urgently. The world runs the risk of growing protectionism and a rising wave of antiglobalisation. Exports could become even more difficult to increase within this looming scenario. It is essential that the trade gap be brought down over the next three years by almost 10 billion US dollars through a strategic and vigorous trade policy.

This was originally published in the Herald's July 2017 issue. To read more subscribe to the Herald in print.

The writer served as a UN assistant secretary general and has published numerous books and articles on governance, public finance and economics.