Deficit woes continue

The current account woes are not going anywhere despite efforts by the government to enhance exports and curb imports. The CAD stood at $3.6 billion (4.2% of GDP) in 1QFY18, up by 117 percent from $1.6 billion (2.2% of GDP) in the same period last year.

Now it's been a year since October 2016 that CAD, on average, is north of $1 billion; and is not likely to improve anytime soon. The current account deficit (read imports growth) started picking up fast ever since the industrial sector production started moving up without the clutches of government support. For instance, the auto sector, electronics, food and beverage etc are growing at encouraging pace. But imports are moving up at a much discouraging pace.

That is the reality of Pakistan economy i.e. even in days of persistent low commodity prices cycle, the imports move up fast as soon as economy grows over 5 percent. The problem compounds amid sluggish exports, flat remittances growth, and the absence of CSF flows.

Thus, if government and central bank have to work on policies to curb current account deficit by having tightened exchange rate, monetary and fiscal policies, the economic (especially industrial growth) momentum has to be compromised. In turn, employment generation will be sacrificed for around million youth coming to labour force every year. And by adjusting exchange rate, inflation would become high too in a matter of months.

Thus, the policy response could be to let the growth momentum continue and also the pace of outflow of foreign exchange due to higher imports in a low inflationary environment. Another option is to tighten the screws to slowdown imports and in turn bring an era of low growth and high inflation.

Of course, on the face of it, anyone would prefer the former; but the question is how sustainable the trend is. The foreign exchange reserves are falling fast - down by $4 billion from its peak of $24 billion in Oct 16. The SBP is fast depleting its ammunition in quest of keeping currency pegged to USD, through pumping dollars in interbank market.

How long can this go on? As without doing anything out of the box, in a year or so, the reserves would fall to a level where panic button would be pressed and the only viable option, based on historical experiences, is to revert to the IMF. The first thing, the IMF would ask is currency adjustment and tight monetary and fiscal policies. This could take the economy back to low growth and high inflationary era.

Point scoring must end and everyone must think on lines to avert the balance of payment crisis without hurting the growth momentum. Think China. Yes, immediately, CPEC, can take the economy out of woods till the time structural reforms are taken to undo the anti export bias and to develop the backward industrial linkages.

This is happening to an extent. The FDI is growing at decent pace lately with bulk of it coming from China; but the FDI as percentage of CAD is too low as compared to what it was in the last high growth momentum in FY05-07 (read: FDI growth, but… published on October 20, 2017). The FDI has to grow and the need is to find more baskets for the eggs. And preferably more eggs too.

Concurrently, efforts to enhance exports should continue. The government is now taking export package more seriously as cash handouts and tax refunds may come directly from SBP to exporters, while central bank can adjust this against government papers.

The exports are up by 12 percent or $624 million to $5.7 billion in the1QFY18; but that is simply not enough seeing the quantum of imports - up by 25 percent or $2.6 billion to $12.9 billion in the same period. Exports were high in August ($2.1bn) as orders for Charismas were there to be dispatched and the toll normalized in Oct ($1.7bn). The trade deficit soared by 37 percent to $7.2 billion in 1QFY18.

Home remittances remained flat in the quarter. The money sent home was exceptionally high in Aug ($2.0bn) but were too low in Sep at $1.3 billion. The low remittances in September is partially explained by seasonality but there might be something else brewing up which will be covered in this column soon. Anyhow remittances, which were covering over 100 percent of trade deficit in previous years, are no more the savior. In 1QFY7, remittances were 90 percent of goods trade deficit while it shrunk to 66 percent in1QFY18.

Now combining FDI and remittances, the number is not enough to fully cover trade deficit. Hence, the reliance is going to be on debt inflows for the time being to keep balance of payment stable. That is why slowdown in imports growth is imperative but without hampering growth momentum.

The government last week came up with another round of duties on non-essential imports which in BR Research opinion (read: Misguided duties published on October 19, 2017) may only generate additional fiscal revenues but would not curb imports.

The government has to think of slashing essential imports and the best way to do is to increase petroleum prices.