Toward a sustainable growth model

Pakistan goods imports have averaged at $6.5 billion for the past six months. That is creating a headache for the policymakers and causing panic in the capital markets. The problem is that economic structure is lopsided and is reaching limits to finance consumption led imported growth. Moreover, imports’ and remittances’ numbers have elements of formalization that is finally showing a more accurate picture.

The economy started opening in 2002 – financial, telecom, and other sectors were deregulated. There was a flurry of external financial inflows. Economic gear shifted up too. It was all hunky-dory till 2007. Economic competitiveness improved due to deregulation and private sector led growth. Big private projects (without sovereign guarantees) were coming online. Exports grew from $9 billion in 2001-02 to $19 billion in 2007-08. Businesses were making money. Salaries of corporate employees multiplied. Real estate started becoming an attractive investment avenue. That has led the country to the next level of consumption.

Domestic consumption grew unabated after 2007-08, but not exports and domestic production. There were power shortages with a bleak law and order situation. That further hampered investment in manufacturing. Almost all investment – local and foreign – came for market seeking opportunities. Protection against imports also spurred growth in those industries.

In the backdrop of stagnating domestic production, consumption growth never stopped. Textile players started investing in domestic brands. International food chains and domestic high-end restaurants relying on imported ingredients started building too. Construction materials’ mix is tilting towards imports. The number of vehicles on roads grew with limited localization. Upper middle-class families started traveling abroad. All of this added to imports while little to no improvement occurred on export front.

The only silver lining in the external account was remittances. Demand for labour in the Middle East created employment opportunities. Pakistan’s gross migrant worker registration averaged at 139,000 employees per year during 1990-2006. There was a quantum jump thereafter. The toll averaged at 556,000 employees per year during 2007-19. The peak number was 946,000 employees in 2015. The number has been falling lately – 224,000 per year in 2020-21.

Official inward remittances’ flow increased from $6.5 billion in 2007-8 to $29.3 billion in FY21. Interestingly, growth of $6.2 billion in FY21 occurred while the number of employees going abroad fell. The primary explanation appears to be the conversion of informal remittances into formal flows due to lower travel and FATF (Financial Action Task Force) implementation. But that does not mean that the overall external account situation is improving too. Growth in remittances is complemented by a similar growth in imports. Then lower travel incidence is also reflected in growth in remittances to net-off demand of foreign currency by travelers.

Thus, one reason for abnormally higher imports lately is better documentation. The incidence of under-invoicing and smuggling is low too. For example, mobile phone imports doubled in two years due to proper reporting and are perhaps less due to higher growth in phones itself. Similarly, petroleum products’ smuggling from Iran has been replaced by official channel imports. Then, the khepia business of bringing household goods (mainly from Dubai) fell due to lower travel. FATF-related laws and regulations are also helping in lowering undocumented trade and remittances.

The imports growth is instead mainly attributable to better energy (mainly power) availability. Most of the new projects that came online in the last decade are based on imported fuel (coal and LNG). That is adding to the bill as well.

In a nutshell, overall import growth is not based on any luxury (non-essential) growth, and has not appeared out of nowhere. The energy sector expansion and improved reporting are the primary reasons. Thus, growth in recent consumption is not unprecedented. The sub-group external account numbers are now closer to reality; but overall external position has not changed as such. Many commentators have noted that super-markets selling solely imported goods are opening up. That may be true. But it is not due to new demand. Instead, they are replacing khepias.

After taking stock of the situation, the question is whether this economic model can sustain going forward. Domestic consumption can no longer rely on remittance growth as the number of employees going abroad peaked in 2015 and has declined thereafter. The trend had pretty much solidified prior to Covid. Either new avenues must open for labour export to grow remittance flow, or goods and services exports must increase. Perhaps a combination of both is needed. FDI (Foreign Direct Investment) needs to be attracted in efficiency seeking sectors. The problem with market seeking FDI is that returns are repatriated in the form of dividends and royalties. That is happening too.

Pakistan needs to revisit its economic model. Limited industrial growth has been based on excessive protection and rent seeking. Businesses make money but don’t fully invest back to gain scale for attaining efficiencies. Foreign firms repatriate profits. Locals take these out through liberal foreign exchange regime.

Since the 1990s, Pakistan foreign exchange regime has mostly been liberal (for individuals) while the industrial protection (through tariffs and other means) is the highest. That is lopsided. People make money through legal protection and tax evasion and take that money outside Pakistan or park it in real estate. The reinvestment in the productive sectors is limited. This structure needs to be revisited by incentivising reinvestment in productive sectors.

Copyright Business Recorder, 2021