Signs of import Substitution

The reported import bill, as per PBS data, stood at $3.6 billion in Aug-19 - lowest monthly number since Jul-16. In case of trade deficit, $1.85 billion is lowest since Mar-16. That is some progress, and the current account deficit is likely to reduce to $200 million - and if the direction continues to remain same, the day is not far to have current account surplus - in FY11 under the IMF the country had a C/A surplus with low growth and high inflation.
It is good news; and a sign of relief as external crisis is somewhat averted. The foreign reserves are showing early signs of good health -the SBP reserves are slowly picking up, and that is without any external debt piling up, apart from foreign portfolio investment (hot money) of $94 million in T-Bills.
Within overall country's foreign reserves, the trend was that SBP reserves were falling while banks reserves were constantly increasing. This implied that private players used to buy dollars while SBP was net seller. August showed a varying picture - SBP reserves increased while the banking reserves fell marginally. This is showing that people are selling dollars to SBP - a much desired policy. However, it may be too early to establish reversal of trend.
In case of imports, another trend could be in making which is necessary for much needed industrialization, import substitution and export promotion. According to news reports, the dutiable imports declined by 35 percent in Jul-Aug primarily due to imposition of regulatory duty on luxury items (read metaphoric cheese) and automobiles. On the flip, machinery and raw material import increased by 7 percent as duty was waived on 1,639 raw materials in the last budget.
Now these are signs of some policy dividends by undoing bizarre policies implemented by Dar. Just to give perspective to the argument, let us go back in the history of national tariff policy and compare it with region to evaluate the impact. Trade liberalization in South Asia started back in 1990s when India and Bangladesh started opening up - reducing tariff rates from around 100 percent (India) and 80 percent (Bangladesh) to 30-40 percent by 1998.
Pakistan was left behind as we relied on protecting domestic industries (read rent seeking) with average tariff of more than 50 percent. High tariffs have made domestic goods less competitive relative to regional competitors.
Pakistan started trade liberalization during 2001-05 and during that time the country's exports grew by 1.7 times. However, the trade liberalization was not uniform in Pakistan as tariff on final products were higher than raw material and intermediate groups. That impeded the backward linkage development of industries - since final goods had higher protection, it resulted in increase in production at final stage but first stage and semi-finished goods imports were encouraged as tariffs were low.
When the economy grows - value-added products are made at home; but the import bill of raw material and parts creates balance of payment crisis. The Musharraf era did not look on that part and now this policy is required to be mended as well. Nonetheless, the trade liberalization policies of 2001-5 were unfortunately reversed in Dar's time. During 2014-17, tariffs were applied from the lens of tax revenues, while trade priorities were kept at the back burner.
The general tariffs slabs were reduced from 10 in 1993 to 5 in 2016 with maximum tariff reduced to 20 percent. However, the import tariff on raw materials and machinery increased from 0 percent in 2014 to 3 percent in 2017 in a staged manner. Apart from that, an additional duty of 1 percent was levied through an SRO to take the duty on raw material and machinery at 4 percent.
The FBR revenues kept on increasing due to that, but the exports stagnated and deindustrialization started in the country. Razzak Dawood being the architect of trade liberalization in 2001-05 is trying to undo the damage done by Dar; and the import duty is waived in 2019 on a large array of raw materials.
The import substitution has started; but for export promotion and creating industrial linkages - tariffs have to be reduced on final goods. This cannot happen till the time foreign reserves are built; but once reserves are built at comfortable stage, protection on final goods has to be reduced - but that requires a battle with business community - not likely in current setup.