State of the BoP

The SBP has recently released the statistics on the balance of payments for Pakistan for the first quarter of 2020-21. It contains one piece of very good news. The current account has actually shown a surplus of $792 million during this quarter. This success has been highlighted even by the Prime Minister. There is need to remind that only three years ago the deficit in the current account was as large as $4338 million in the first quarter of 2017-18.

What explains this spectacular turnaround in the current account deficit? The primary explanation is the increase of $1695 million in home remittances, equivalent to a big rise of 31 percent. However, the trade deficit in goods has increased somewhat by $204 million. There is some reason for concern about the significant drop in exports of 11 percent. However, this was to be expected given the deep recession in the major export markets following COVID-19.

There is also a positive development in the trade deficit in services which has declined by $669 million due to the big fall in imports of services of 26 percent. However, there has been a minor deterioration in the balance in primary income of 7 percent due probably to increased repatriation of profits by multinational companies in Pakistan.

The problem is that even though the current account is showing a surplus for the first time after many years, there is still a deficit in the overall balance of payments of $423 billion. Coupled with the repayment to the IMF of $212 million, this has led to a significant fall in foreign exchange reserves of $635 million, despite the current account surplus.

Why has this happened? The answer lies in the fact that the financial account of the balance of payments has gone into a deficit of $741 million during the quarter. The financial account was in surplus to the tune of $1995 million in the first quarter of 2019-20. Therefore, there has been a major deterioration in the financial account of as much $2736 million. This has more than neutralized the improvement in the current account of $2284 million.

There has, in fact, been a big change in the nature of balance of payments of Pakistan. Historically, the current account used to be in a deficit position while the financial account generally was in surplus. Perhaps for the first time, the pattern of the balance of payments has been reversed. Now the current account is in surplus while the financial account has gone into a deficit.

The deterioration in the financial account is due, first, to the big decline in foreign direct investment of 27 percent. Second, there has been a net outflow of equity funds worth $ 60 million as compared to an inflow of $456 million in the corresponding quarter of last year. Third, a major factor is the decline in loans to the Government account from bilateral and multilateral agencies of over $1.2 billion to $1.8 billion from $3 billion last year. Fortunately, amortization has been $482 million less due particularly to the debt relief provided by the G-20.

What is the outlook for the balance of payments in the remaining quarters of 2020-21? There are no grounds whatsoever for any complacency. Already, there was only a marginal surplus of $73 million in the current account in September. There is also uncertainty about continued high growth of remittances. In fact, the World Bank has projected that remittances could fall globally by $100 billion in relation to the pre-COVID level of $350 billion, due to the large number of returning workers especially from the Middle East.

There is also the likelihood of a hump in imports due to the large shortfalls in output of wheat, sugar and cotton. In order to ensure adequate supply and prevent further price hikes there will be need to import over 2 million tons of wheat, 0.5 million tons of sugar and over 4 million bales of cotton. A conservative estimate of the cost of these imports is $2.5 billion.

There are also likely to be more constraints to external borrowing in the absence of an operational IMF program. The programme has already been in a state of suspension for over nine months now. The two major sets of reforms relating to the management of the circular debt of the power sector and of raising tax revenues by 23 percent in 2020-21 require hikes both in the tax rates and in power tariffs. This has become difficult in an environment of the rate of inflation approaching double-digit.

The target for external borrowing by the Government in 2020-21 has been set at $12 billion. Only $1.8 billion, or 15 percent, has been received in the first quarter. In the absence of an on-going IMF programme there may be greater reluctance of international commercial banks to lend to Pakistan. Further, flotation of Sukuk or Eurobonds will need to offer very high returns in the form of a risk premium.

The situation has become more volatile with the protest rallies launched by the newly-formed 11-party opposition alliance, the Pakistan Democratic Movement (PDM). Increased perceptions of uncertainty may lead to exit of more funds from Pakistan, even less foreign investment and a bigger constraint politically to the implementation of reforms agreed earlier with the IMF. This could lead to further postponement of resumption of the programme and of tranche releases to support the balance of payments.

The Ministry of Finance and the SBP will have to be even more watchful of developments in the balance of payments. The limit through acquisition of swap funds to increase foreign exchange reserves of the SBP has, more or less, been reached. If reserves falter especially at the time of larger imports of agricultural products or if remittances flatten out then the balance of payments could become more fragile. All efforts will need to be made to avoid such a situation.

(The writer is Professor Emeritus at BNU and former Federal Minister).

Copyright Business Recorder, 2020