Unsustainable BoP

The State Bank of Pakistan (SBP) has just released the numbers on the external balance of payments (BoP) position for 2021-22. The current account deficit for the year has closed at $17.4 billion, equivalent to almost 5 percent of the GDP. This is the second largest deficit ever, after the $19 billion deficit in 2017-18.

The 11-month deficit was $15.2 billion. As such, the expectation was that inclusive of the deficit in June, it would probably reach $16.5 billion by the end of the year. Instead, it is almost $1 billion higher. This is due to the much larger deficit in June of $2.3 billion, 64 percent higher than the deficit in May. Clearly, measures taken to stabilise the balance of payments position are failing to yield the desired results.

The trade deficit in goods is almost $40 billion. This is over 38 percent higher than the deficit in 2020-21. The primary cause, of course, is the huge increase in commodity prices in 2021-22, due initially to the process of global recovery after Covid-19 and more recently because of the supply shortages created by the Russia-Ukraine war.

Exports have performed well with an exceptionally high growth rate of almost 27 percent. But they are only about half the level of imports. Imports have, in fact, shown even faster growth of 30 percent. Consequently, there has been a large widening of the trade deficit.

During the fourth quarter of 2021-22 a number of steps have been taken to restrict imports. The SBP has increased the policy rate and enhanced the coverage of import margin requirements. The government has introduced a ban on some luxury and non-essential imports. But imports have continued to grow relentlessly. The growth rate in the fourth quarter in relation to imports in the third quarter remained positive at 7 percent, despite the measures.

The other parts of the current account have also shown a big deterioration in 2021-22. The deficit in services has more than doubled, primarily because of the hike in freight charges. Interest payments and repatriation of profits have also increased by 20 percent.

Inflows into the secondary income account have remained largely unchanged. Workers’ remittances did show some growth of 6 percent, but other current transfers saw a large decline of 59 percent.

However, there is some good news about the size of inflows into the financial account of the balance of payments in 2021-22. These have aggregated to $11.1 billion, 26 percent higher than in 2020-21. However, there are contrasting trends in the different components of the financial account.

A very negative development is the plummeting down of foreign investment, direct and portfolio, into Pakistan in 2021-22. It is only one-third of the level in 2020-21. This is a very clear indicator of the loss of confidence of foreign investors in the economy of Pakistan.

There is a modest increase of 7 percent of the net inflow into the government account. The disbursement is $14.4 billion, which is over 24 percent higher than the level last year but still $3 billion less than the budgeted level.

However, another worrying development is the big growth in amortization payments from $5.9 billion in 2020-21 to $8.3 billion in 2021-22. The overall position in the financial account has been strengthened by the receipt of $2.8 billion of SDRs (Special Drawing Rights) from the IMF (International Monetary Fund).

The bottom line of the balance of payments in 2021-22 is a big negative outflow of $6.3 billion. The large current account deficit of $17.4 billion, has been financed only to the extent of 65 percent by net inflows into the financial and capital accounts. This is in sharp contrast to the positive balance of payments position in 2020-21 of $5.6 billion, due largely to the extremely low current account deficit of only $2.8 billion.

The consequence is that 2021-22 has witnessed a substantial depletion of foreign exchange reserves. They are down from $17.3 billion at the start of the year to only $9.8 billion on the 30th of June 2022. At this level, they can provide import cover for hardly one and a half months.

The minimum safe level is of three months cover. Therefore, foreign exchange reserves are only half the minimum safe level. It is not surprising that this, along with other factors, has precipitated a big decline in the value of the rupee.

The task for stabilising the economy is huge for 2022-23. Otherwise, there will be growing perceptions in the markets that Pakistan is reaching a state where it may not be able to fully honour its external payment obligations.

First, the target must be to virtually halve the current account deficit in 2022-23 in comparison to the level of 2021-22. This will require limiting the deficit to below $9 billion. Exports are unlikely to show much growth in the presence of the looming global recession and less of competitiveness due to the big jump in energy, transport and other input costs.

Therefore, bulk of the adjustment will have to come by reduction in the import bill by over one-eighths. This implies that monetary, fiscal and trade policy instruments will have to be used even more intensively and in a sustained manner.

According to the latest commodity price projections by agencies like the IMF, they are likely to decline significantly in coming months from the current inflated levels. But the average prices in 2022-23 may not be significantly lower than the average level in 2021-22, because they were very low in the first half of the latter year. Therefore, bulk of the cut in imports will have to come from lower import volumes, with consequent implications on growth and inflation.

Pakistan’s economy is today on a knife edge. Even in the presence of a functional IMF programme there may be limits to capital inflows into the country, especially because of the lack of political stability. Consequently, the budgetary target of $23 billion of external loans will be difficult to meet, especially in terms of access to the international bond market and commercial loans.

Pakistan today faces one of the worst financial crises in its history. There is need for the highest quality of economic management, for a cooling down of the political temperature and move towards a consensus on much needed structural reforms. We hope and pray that our country will once again emerge successfully from a big crisis.

Copyright Business Recorder, 2022