Managing the BoP

The balance of payments (BoP) figures for the full-year, 2022-23, have just been released by the SBP. They reflect many unusual features. Compared to 2021-22, the current account deficit has declined by as much as $14.9 billion, from $17.5 billion in 2021-22 to only $2.6 billion in 2022-23.

However, the big improvement in the current account deficit has been largely neutralized by a massive deterioration in the financial account of the balance payments of $12.9 billion. It was in surplus of $11.3 billion in 2021-22, which has turned negative at $1.6 billion.

Consequently, despite the phenomenal improvement in the current account position, there has been a fall in foreign exchange reserves in 2022-23 of $5.2 billion. This is $2.3 billion less than the fall in reserves in 2021-22.

There is a need to carefully diagnose first the causes of improvement in the current account and then identify the reasons for the substantial worsening of the financial account in 2022-23.

The biggest source of improvement in the current account is the phenomenal and unprecedented decline in imports of goods of $19.5 billion, from $71.5 billion in 2021-22 to $52 billion in 2022-23. This represents a big drop of almost 27%.

The decline in imports is largely due to the physical controls exercised by the SBP, with some impact also of higher import margins, levy of some duties and a big enhancement in interest rates directly impacting on the import of capital goods. The currency has also been devalued during the year by approximately 37%, according to the PBS (Pakistan Bureau of Statics) import data.

The consequence is that all groups of imports have declined in dollar terms in 2022-23, with the fall ranging from 61% in the case of the transport group to 1% in food imports. Estimates of the unit values in dollars reveal that on average there has been a drop in import prices of 4% in 2022-23.

As such, with the decline in value of 27%, the actual volume of imports has fallen by as much as 31%. This is unprecedented and inevitably it has resulted in a big fall in production in sectors like large-scale manufacturing and construction by 6% to 10%.

The BNU Macroeconomic Model has been used to estimate the extent to which imports have been restricted physically. The resulting magnitude is $11 billion. If instead a market-based exchange rate policy had been adopted to achieve the same quantum reduction in imports, then the required rate of depreciation of the rupee would have been 63%, as compared to the actual decline of 37%.

There is evidence of other restricted outflows in the services and primary income accounts. However, this has also been neutralized by the 14% fall in remittances of almost $5 billion. This is attributable to the large deviation between the exchange rate in the inter-bank and open markets, especially in the second quarter of 2022-23.

Turning to the financial account, as highlighted above, there has been a decline in the net inflow into this account of as much as almost $13 billion in 2022-23. This is due primarily to a fundamental worsening of net inflows into the Government account.

Disbursements are down by almost 34%, while the amortization payments are up by 41%, leading to a net outflow of $2.1 billion from this account. Other negative developments include a reduction of 83% in the net inflow of foreign direct investment and some fall in other private sector inflows.

The bottom line is a fall in foreign exchange reserves in 2022-23 from $9.8 billion at the start of the year to $4.5 billion by the end of year. Therefore, the year, 2023-24, starts with an import cover of reserves of only 0.9 months. Fortunately, the first two weeks have witnessed significant inflows of $4.5 billion, including from the IMF (International Monetary Fund), following the approval of $3 billion Stand-By Facility to Pakistan.

The fundamental question is what will be the likely developments on the balance of payments front in 2023-24? Along with the press note announcing the SBA for Pakistan, a first set of macroeconomic projections have been released for 2023-24 by the IMF.

According to these projections, the targeted level of the current account deficit in 2023-24 is 1.8% of the GDP, equivalent to approximately $6.5 billion, a significant increase over the level of $2.6 billion in 2022-23. Further, the IMF expects that reserves will rise by $4.5 billion and reach $9 billion, equivalent to import cover of 1.3 months.

The understanding now of the IMF with the government is that there will be no resort to physical controls and that instead a fully market-based exchange rate policy will be used to manage the balance of payments and ensure achievement of the targets.

The basic question is how much space will become available to enhance the level of imports and ensure that the GDP growth rate of 2.5% is achieved? With a positive response of exports and home remittances to the market-based exchange rate policy and with minimum divergence between exchange markets, there is scope, according to the model, for increase in imports of $12.7 billion according to the IMF projections, equivalent to an increase of over 24%.

With international commodity prices floundering somewhat due to the global recession, the volume of imports could rise substantially by almost 30%. However, the extent of depreciation in the exchange rate projected by the IMF in 2023-24 is 20.6%. However, the rupee may have to fall more to limit the current account deficit to 1.8% of the GDP.

According to the IMF, the disbursement of overall external assistance, net of rollovers, will need to rise substantially from $9.9 billion to $14.7 billion. Surprisingly, the amortization of external debt is expected to fall by $4.8 billion, due particularly to more rollovers of commercial debt.

Overall, there has been a significant boost to the level of confidence in the economy following the SBA finalization and significant inflows.

However, the later months of 2023-24 will require the highest quality of economic management, especially by the SBP, with skilful use especially of the policy instruments of the exchange rate.

Simultaneously, the Ministry of Finance will need to limit the budget deficit to the targeted level to reduce the pressure on the current account of the balance of payments.

Copyright Business Recorder, 2023