Risks to BoP

As the IMF leaves Pakistan, it has prepared a set of projections of the balance of payments for the next few years as part of the 11th Review. These projections indicate that the external transactions of Pakistan have attained a stable and sustainable position. Foreign exchange reserves will most likely continue to rise in the medium-term. Pakistan should be in a comfortable position to repay the Fund from 2017-18 onwards and meet all its other external debt repayment obligations. Clearly, the IMF wants to demonstrate that the EFF over the last three years has been a success and that Pakistan is in a position now to go it alone. This may have created a sense of complacency in Islamabad.
The optimism is based on a number of key assumptions and projections thereof by the IMF. First, exports are expected to show some buoyancy and grow by almost 7% annually up to 2018-19. Second, there could be jump in imports of 8% annually due to rise in oil prices and large power sector machinery imports. However, the latter will be fully financed by capital inflows from China as part of the CPEC. Third, remittances will continue growing at a low but positive annual rate of 4%. Fourth, foreign assistance inflows, including from the Coalition Support Fund, will continue at high levels. Fifth, Pakistan will be successful internationally in floating sovereign bonds and engaging in commercial borrowing at reasonable cost, without too large a risk premium.
Unfortunately, the first warning bells have already been sounded, in contrast to the IMF projections. In the first month, July, of the current fiscal year, 2016-17, remittances have plummeted by 20%; exports have declined by 7% while imports have shown increase of 6%; foreign direct investment is down by 15% and the US has stopped release of $300 million due from the CSF. The current account deficit is likely to have reached $500 million in July. All these negative developments have led to fall in foreign exchange reserves of over $400 million in the last six weeks. Hopefully, these worrying developments are not fully representative of the likely trends in coming months.
But the time has definitely come to focus on the risks associated with the future balance of payments position. This will help to identify the steps needed to avoid a precipitate fall in foreign exchange reserves, as happened after 2010-11 following the premature end of the Stand-By Arrangement (SBA) from the IMF. International perceptions should, however, be different this time as Pakistan has successfully completed the twelve quarterly reviews under the three-year EFF with the IMF.
Top most priority has to be placed on the revival of exports. The government has set up a mechanism for zero-rating exports of some key sectors in the budget of 2016-17. It is necessary to ensure that this is implemented smoothly. A commitment has been made to pay the outstanding refunds due to exporters by the end of August 2016. This has not happened yet and must take place in the next few days.
Beyond these steps, some other policies need to be implemented on a priority basis. The rupee is overvalued by over 17% and this has severely affected the competitiveness of exports and cheapened the cost of imports. A significant depreciation of the value of the rupee will help in arresting the decline in exports and restricting non-essential imports. Regulatory duties do help in containing imports but the exchange rate move works on both fronts. Empirical research on Pakistan trade has demonstrated that with a 10 percent depreciation of the rupee, exports could rise by 8% and imports fall by 3%, within two years. The low rate of inflation provides an appropriate cushion.
In the current environment of slow growth in the world trade, we need to realise that there is a low intensity but visible trade war going on in the form of competitive devaluations of currencies. Even China, with massive reserves of $3.3 trillion, has been compelled to depreciate its currency by 8% over the last two years. India has suffered a big drop in exports and adjusted its currency downwards by 10%. Turkey has aggressively promoted its exports, especially to the EU, by bringing down the Lira by 35%. Other significant moves include currency depreciation by Indonesia of 12%, Malaysia by 27% and Thailand by 9%. During the same period, the value of the Pakistan rupee has fallen less, by 5% only. Large external borrowings leading to an accumulation of reserves have artificially stabilised the rupee.
Beyond the change in exchange rate policy, other incentives may have to be offered, especially to value added manufactured goods and for promotion of exports to emerging markets. An export rebate of up to 5% could be made available to compensate for the duty component on imported raw materials and for the relatively high cost of energy in Pakistan.
As a general policy, not restricted only to SEZs, foreign direct investment in Pakistan may enjoy a 10-year tax holiday and exemption from customs duty on import of machinery. Further, the Federal and Provincial Boards of Investment need to organise proper 'one-window' operations to facilitate foreign investors. The Pakistan Remittance Initiative (PRI) must be developed to provide attractive investment opportunities in the country for overseas Pakistanis.
There is a great sense of urgency to manage the downside risks associated with the external balance of payments. Otherwise, latest by 2018-19, there is the danger that servicing of external debt could become a major problem in the face of falling reserves. At that time, international support may be possible not only with the usual economic prior actions and implementation of conditionalities but also with some concessions on other fronts. This must be avoided at all costs.
(The writer is Professor Emeritus and former Federal Minister)