Gathering clouds on the external front

It was a matter of great satisfaction to be told some time back that structural imbalance in the current account, which was a source of many economic problems including mounting external debt, had been finally removed and the country was not far from the goals of self-reliance and solvency.
Looking at the latest data, however, the rosy possibility now appears to be no more than a wishful thinking. After recording a surplus for three successive years, Pakistan posted a current account deficit of 1.6 billion US dollars in FY05 and the trend during the current year has worsened.
According to the data now released by the State Bank, the current account deficit widened to 1.427 billion dollars in the first quarter (July-September) of 2005-06 or nearly close to 1.6 billion dollars full year deficit of the last fiscal.
The reversal seems to be alarming when compared to the surplus of 119 million dollars registered in the same period last year. The data posted on the website of the central bank showed that the main reason behind this adverse development was the sharp increase in trade deficit mainly because of high global oil prices and increasing demand for imports, particularly for raw materials and machinery.
The weakening of the current account has already started affecting the foreign exchange reserves and could result in a further dip in the reserves if the present trend continues. The situation during 2004-05 did not cause much anxiety because of significant capital inflows like 364 million dollars through privatisation, 600 million dollars through sovereign debt issued internationally and a jump in concessional long-term loans from the World Bank and ADB.
Such one-off inflows can obviously help but only temporarily and cannot be relied upon as a sustainable source to bridge the gap between foreign receipts and payments of the country.
The position in the near future is not expected to be any better. While exports are likely to maintain healthy growth, the smaller base relative to imports means that in absolute terms the trade deficit may widen, putting further pressure on the current account.
According to the State Bank report released in the last week of October, the current account deficit may rise to 3.1 percent of GDP as compared to 1.4 percent last year. Higher than expected deficit recorded during the first quarter of FY06 (over 1.1 percent of GDP) may force the authorities to raise even these estimates upwards.
The sharp jump in the current account deficit might erode the hard earned foreign exchange reserves of the country which have already slipped from 13 billion dollars in April, 2005 to the present level of less than 12 billion dollars.
The sale of family silver may provide a temporary relief but if the alarming trend continues, it could ultimately push the country back on the bumpy track of pre-1999 era when the State Bank had reserves sufficient only for a few weeks of imports.
It is sometimes argued that the present exceptional growth of machinery, raw materials and other imports would, with the passage of time, lead to reduction in the trade imbalance and improve current account balance of the country. Of course, the assumption here is that the resulting increase in productive capacity would translate into further strengthening of exports in the coming years.
However, the timing and extent of this possible transformation remains in question. In particular, the expected sharp growth in exports may not materialise if domestic demand remains strong and price pressures in the economy are allowed to accentuate.
All of this, in our view, should be a cause of great concern for the policy makers of the country. The gathering clouds on the external sector could turn into a serious menace to the economy. The raising of sovereign debt on some pretext or the other and the proceeds earned from privatisation are not a proper solution to the problem.
It must be understood that any worthwhile progress in this regard would depend crucially on the incentives available to exporters, including pro-export government policies and supportive exchange rate environment. Appropriate policies need to be designed particularly to curb domestic consumption and encourage exports.
Downward adjustment in the rupee rate should not be made an issue of prestige. It is fortunate that imbalances in the external sector are not yet big enough to be a serious threat to the normal flow of foreign trade, but the problem needs to be tackled urgently with due care before it reaches a crisis point.