Pakistan's overall external balance recorded a deficit of US$ 1.6 billion in Jul-Mar FY17, against a surplus of US$ 1.1 billion in the same period last year. This was mainly caused by a large trade deficit on the back of high imports without a matching performance by exports. The imports of fuel, machinery and food items (mainly palm oil and pulses), all increased sharply due to robust domestic demand and ongoing power and infrastructure development activity.1 This dynamic pushed the current account deficit (CAD) to US$ 2.6 billion in Q3 the highest since Q2-FY09. The higher CAD was recorded despite the receipt of US$ 550 million inflow under Coalition Support Fund in the third quarter. For Jul-Mar FY17, the current account gap amounted to US$ 6.1 billion, over twice the level recorded in the same period last year (Table 5.1).
The following are excerpts from State Bank of Pakistan's Third Quarterly Report 2016-2017 titled 'The State of Pakistan's Economy'.
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Table 5.1: Summary of Pakistan's External Sector
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(million US$)
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Q3 Jul-Mar
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FY16 FY17 FY16 FY17
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Current account balance -449 -2,570 -2,351 -6,114
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Of which
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Trade balance -3,933 -6,893 -13,356 -17,748
Exports 5,545 5,600 16,328 16,120
Imports 9,478 12,493 29,684 33,868
POL imports 1,614 2,771 6,398 7,769
Non-oil imports 7,864 9,722 23,286 26,100
Food 1,160 1,503 3,367 3,993
Transport 467 641 1,331 1,852
Machinery 1,532 2,024 4,602 5,275
Services balance -746 -304 -2,033 -1,993
Coalition Support Fund 0 550 713 550
Worker remittances 4,699 4,600 14,388 14,058
Capital account balance 47 150 213 260
Financial account balance 107 -1,138 -3,372 -4,805
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Of which
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FDI in Pakistan 446 501 1,425 1,601
FPI in Pakistan -613 -114 -393 631
Euro bond/Sukuk 0 0 500 1,000
FX loans (net) 1,109 229 3,769 1,964
IMF 503 0 1,455 102
Overall balance* 315 1,841 -1,144 1,614
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Though the SBP's reserves hit a peak of US$ 19.5 billion (in October 2016) as proceeds from US$ 1.0 billion Sukuk were received, sustaining that level was not possible in the wake of an increasing current account gap; lower external government financing; and the conclusion of the IMF program.2
Particularly, the FX reserves declined in the third quarter of FY17, as: (i) the monthly CAD crossed the US$ 1.0 billion mark in January 2017; (ii) Pakistan repaid US$ 500 million of SAFE China Deposits, also in January; and (iii) the merchandise trade deficit grew by almost US$ 3.0 billion YoY in Q3-FY17. While CSF inflows did materialize over the next two months and provided some breathing space, SBP's liquid FX reserves declined to US$ 16.5 billion by end-March FY17, from US$ 18.3 billion at end-December 2016. These were, nonetheless, sufficient to finance over four months of the country's merchandise import bill.
That said, the country did have access to funding avenues, both public and private, which partially financed the higher current account deficit. Net official external financing inflows in Jul-Mar FY17 in the form of project, non-project and commercial loans, and sovereign bonds stood around the same level as last year (ie US$ 1.9 billion). This indicates that IFIs and international capital markets are comfortable with Pakistan's growth trajectory.3 In addition, foreign direct investment (FDI) inflows also increased; in a departure from last year, a majority of these flows came from countries other than China.4 Net FDI from China rose marginally over last year, with investment mostly flowing into power and infrastructure projects; the 40 percent stake sale of the Pakistan Stock Exchange to a Chinese-led consortium also netted the country's foreign investment worth around US$ 61 million in March 2017.5
However, as mentioned earlier, these inflows were not sufficient to fully offset the widening in the current account gap. The following points are worth noting in this regard:
(i) The Q3-FY17 import bill hit an all-time high, pushing the Jul-Mar FY17 imports to their record as well. This occurred as non-oil imports kept on their rising trajectory, largely reflecting: (a) progress on power generation and road infrastructure projects, as well as capacity expansions and upgradation pursued by industries like textiles and cement (which boosted machinery imports); (b) a drop in domestic production of minor crops (mainly pulses), which necessitated higher purchases from abroad; and (c) a price-driven hike in palm oil imports.
Meanwhile, the US$ 1.4 billion increase in the POL import bill in Jul-Mar FY17 (contributing 32.6 percent to the overall rise in import payments in the period) is largely driven by higher quantums.6 Despite the recovery in international oil prices, unit values of Pakistan's POL product imports are still lower as compared to last year (Figure 5.1). While the price impact for crude oil turned positive from Q3-FY17 in line with the movement in international oil prices7 yet, higher quantums still seem to be driving the increase in Pakistan's overall energy imports.
On this front, the government's decision to partially pass on the increase in global oil prices to domestic POL prices from December 2016 onwards, seems to have had a dampening effect on demand for POL products, as reflected by a slowdown in sales growth of both HSD and petrol in Q3-FY17 (Figure 5.2).8 Per litre prices of the two fuels were raised by Rs 5.8 and Rs 5.6 respectively in the third quarter, after having been kept almost unchanged during the previous two quarters.9
(ii) Pakistan's export recovery lags behind other EMs'. Like many other emerging markets (EMs), Pakistan also faced a challenging export environment over the last two years with subdued commodity prices, muted demand from key western markets, and decline in shipments to China. However, many of these external dynamics had reversed by mid-2016: international cotton prices increased during Jul-Mar FY17,10 and overall imports of key markets like the EU also rebounded.11
The confluence of these developments and the positive demand shock they generated, have contributed to a recovery in exports of multiple emerging markets (EMs) from Q2-FY17 onwards (Figure 5.3).12 However, Pakistan's export performance during this period looks weak.
One reason is that Pakistan's clothing and home textile products are fetching lower unit values in the key EU market than those of its competitors (Section 5.4). Both the product quality and competitive pricing issues seem to be at play here; exporters are also reported to be undercutting their margins by trying to out-price their competitors. For low-value added textile products, the recovery in international cotton prices over the past 12 months has translated into higher unit prices, but their export receipts are being pulled down by lower quantums. On an encouraging note, basmati rice exports recovered in Q3-FY17, mainly as a result of higher shipments to the UAE and Iran.13
(iii) The decline in remittances has been offset by lower profit repatriations. The nominal YoY decline in worker remittances amounted to US$ 330 million in Jul-Mar FY17. However, the decline in remittance inflows was more than offset by a US$ 371 million YoY decline in outflows in the form of profit and dividend repatriations, particularly by foreign oil and gas firms.
To sum up, Pakistan's external account has come under pressure due to an unfavorable trade balance. While a large share of imports is geared for growth-oriented activities, sluggish exports are more worrisome. To rectify this imbalance, the private sector needs to take the lead, by demonstrating an entrepreneurial spirit and investing in physical and human capital, in order to offer more competitive products in international markets.
Moreover, the changing global economic scenario also offers enhanced trade prospects, as the IMF now projects a brighter outlook for advanced economies.14 This is particularly true for the US, where the new administration's fiscal policy proposals (a combination of hefty tax cuts and ramp up in infrastructure spending) are fuelling optimism. Besides, Europe and Japan are also expected to benefit from a recovery in global manufacturing and trade. That said, only those EMs can hope to benefit from this evolving dynamic, that have: a strong reliance on regional trade; competitive industries; and a policy regime that shows flexibility and prioritizes market efficiency at the same time.
Pakistan can capitalize on these opportunities if it pursues long-lasting structural reforms, while private businesses in the country do a fundamental rethink about the way they operate and prioritize long-term growth over short-term profits. While the country did utilize the window of opportunity provided by low oil prices and IMF support over the past few years by building up FX buffers and addressing some supply-side bottlenecks, keeping up the reform momentum will be important, going forward.
Meanwhile, rationalizing domestic POL prices with international rates (Chapter3), minimizing market distortions, and discouraging unnecessary consumer imports by utilizing the full extent of regulatory measures at the disposal of fiscal and monetary authorities, are some steps that should be taken in the short-term to create financing space for critical capital goods imports.
(To be continued)
1. The IBA-SBP Consumer Confidence Index reached its highest level of 176.5 points in March 2017, up 18.6 points from the level recorded in July 2016, which indicates increase in demand.
2. SBP had received US$ 1.5 billion under the Extended Fund Facility in Jul-Mar FY16, and only US$ 102 million (as the residual tranche) in Jul-Mar FY17.
3. In May 2017, the credit ratings agency Moody's maintained its B3 rating for Pakistan, with a "stable" outlook.
4. This was mainly due to the conclusion of two acquisition deals in the food and electronics sectors by non-Chinese firms in the second quarter, which contributed a cumulative US$ 587.7 million to net FDI inflows during Jul-Mar FY17.
5. While the total proceeds realized from the PSX stake sale amounted to around US$ 85 million, the component received from foreign investors was US$ 61.1 million (recorded as foreign investment), with the rest coming from domestic partner firms in the Chinese-led consortium.
6. Another factor has been the rise in LNG imports into the country. According to SBP data, the LNG import bill amounted to US$ 844.0 million in Jul-Mar FY17, up 129 percent on YoY basis.
7. Average Saudi Arabian Light oil prices during Q3-FY17, at US$ 52.9 per barrel, were 77.3 percent higher than they were in the same period last year (source: Bloomberg).
8. In case of petrol, it is also possible that some consumers who had shifted to the fuel from CNG after the sizable reduction in petrol prices in 2016, have now switched back to CNG, following the increase in POL prices from Q2-FY17 onwards. Though per litre petrol and per unit CNG prices technically should not be compared due to differences in the nature of the fuels, it can be used as a rough proxy for discerning shifts in consumer behaviour. In January 2016, petrol prices were Rs 6.1 higher than per unit CNG prices. This differential had turned a negative Rs 5.9 in March 2016 (ie per unit CNG prices were Rs 5.9 higher than petrol prices). But after declining consistently since then, this differential had again reversed to a positive Rs 1.2 by March 2017.
9. Petrol and HSD prices were unchanged during Jul-November FY17, before rising by Rs 2.8 and Rs 3.2 respectively in December 2016.
10. Average international cotton prices during Jul-Mar FY17 were 14.5 percent higher as compared to Jul-Mar FY16 (source: Bloomberg).
11. Overall imports of EU-28 countries rose by 3.7 percent YoY in Jul-Mar FY17, after declining by 11.6 percent in the same period last year (source: Eurostat).
12. Yet, at the same time, clouds of protectionist and anti-trade sentiments swirl overhead and threaten the sustainability of this EM export rally. In fact, these sentiments prompted the IMF to note in its World Economic Outlook April 2017 that " the post-World War II system of international economic relations is under severe strain despite the aggregate benefits it has delivered and precisely because growth and the resulting economic adjustments have too often entailed unequal rewards and costs within countries".
13. Pakistan's trade with Iran is likely to improve in the coming months, after SBP and the central bank of Iran devised a payment settlement mechanism (in Euros and Yen) for trade transactions between the two countries. In this regard, SBP issued relevant directions to Pakistani banks in May 2017, via FE Circular No. 4 of 2017.
14. According to the IMF's World Economic Outlook for April 2017, advanced economies are likely to grow by 2.0 percent in 2017, up from last year's rate of 1.7 percent. The latest 2017 growth projection is also higher (by 0.1 percent) than the Fund's projection in January 2017.
Copyright Business Recorder, 2017
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