The external trade statistics have been released somewhat belatedly by the Pakistan Bureau of Statistics for the months of July and August 2019. These statistics need to be analyzed carefully to determine why exports have registered a growth rate of less than 3 percent during these months while imports have plummeted by over 21 percent. Consequently, the trade deficit has declined by almost 36 percent in relation to the level in the corresponding months of 2018. Over 95 percent of the reduction in the trade deficit is due to the big curtailment of imports. The targeted contraction as per the IMF programme scenario in the trade deficit is 16 percent. Therefore, initial success has been achieved in the containment of the trade imbalance for 2019-20. However, a bigger reduction in the trade deficit is required because of falling remittances and a big increase in the trade deficit in services.
However, a number of questions arise about the implications of this big cut in the trade deficit. Medium-run sustainability of the balance of payments requires that exports begin to show more buoyancy with near double-digit rates of growth. But why have exports demonstrated little increase despite a near 34 percent devaluation of the rupee in 2018-19? The second question relates to the quantum decline in imports. How much of the fall is due to a fall in import prices in dollars and how much is the result of a fall in quantities? If the decline in quantities is the major factor then is this widespread across most imports or restricted to only a few product groups?
We analyze first the developments on the export front. It is perhaps a surprise that almost 80 percent of the only $102 million increase in exports is actually in the food group, with a growth rate of over 14 percent. In fact, the rise in rice exports alone of $109 million is more than the total increase in exports.
Textile exports have risen by $52 million, with a growth rate of only 2 percent. Exports of other manufactures have actually fallen by $16 million or 3 percent. Within the textiles group there have been significant declines in exports of cotton yarn and cotton cloth of 8 percent and 6 percent respectively. Fortunately, knitwear and readymade garments exports have performed well with growth rates of 13 percent and 8 percent respectively. Within the other manufactures group, buoyancy is visible only in export growth of 25 percent in surgical goods.
The impact of devaluation on exports hinges crucially on the extent to which the dollar prices have been brought down by exporters, especially in the presence of a fall in the value of the rupee of 34 percent. The surprise is that across the range of major exports, the price charged from importers in dollars has been reduced on average by only 13 percent. Clearly, this has implied only a limited increase in competitiveness.
Textile exporters have, in fact, demonstrated contrasting behavior depending on the product being exported. The average export price in dollars has actually risen by 3 percent in the case of knitwear and by 2 percent in cotton cloth exports. The response in terms of quantity demanded has been substantial in cases where big price reductions have been offered. A perhaps spectacular example is of readymade garments. The export price was reduced by 27 percent and the response was a 35 percent increase in the number of garments demanded by international buyers. Similarly, a 19 percent decrease in the average price of bedwear has led to a 20 percent increase in quantity exported.
There is need to explain why the big devaluation of 34percent was not fully transmitted into lower export prices. This has clearly limited the impact on the level of exports. Two potential explanations can be offered. First, imported input costs of exports have gone up simultaneously. In addition, there has been some inflation in costs of local inputs. These could have had the effect of increasing input costs by about 16 percent with the share in value of production of about 60 percent. Therefore, almost 10 percentage points of the 34 percent devaluation have probably been lost due to higher costs. This means that up to 24 percent reduction in the dollar price was feasible on average. But the overall reduction in prices, as highlighted earlier, is 13 percent. This takes us to the second explanation. It is likely that some export industries had the constraint of limited excess capacity and, therefore, could not be aggressive in their export marketing. Instead, the option of taking a higher rupee profit margin was chosen.
The lesson to be drawn from the experience with the performance of exports is that there is need to focus more on containment of input costs and to ensure enough liquidity with exporters, especially the SMEs. Also, liberal incentives ought to have been offered for a quick response of investment. Instead, the budget of 2019-20 has in a somewhat bizarre manner reduced the tax credit for BMR and the initial depreciation allowance.
The emerging story on the curtailment of imports also has implications for management of the economy. There has been a big decline in the value of imports in eight out of the nine product groups. This includes major groups like petroleum, transport, food, agricultural goods and chemicals. The fall ranges from 36 percent in the transport group to 23 percent in the agricultural goods and chemicals group. The only group which has shown an increase in the value of imports of 8 percent is the machinery group. This is a positive development. In particular, the motivation to invest has increased in the textile industry and the import of machinery has gone up by 17 percent in the last two months.
Perhaps contrary to expectations, the big decline in the overall value of imports of 21 percent is due not only to fall in quantity imported but also because of a fall in import prices in dollars. The quantity index of imports in overall terms has fallen by 16 percent while the overall unit value index in dollars is down by 5 percent.
The big declines in quantities imported raises concerns about the fall in import demand due to the on-going process of slowdown in the economy. The largest observed fall in quantities imported of 35 percent is in the metals group, especially of iron and steel. This highlights the severe contraction in construction activity that has taken place in the country. The decline in the volume of imports of food items like palm oil, tea and sugar is a reflection of the fall in consumer demand due to rising domestic prices.
The big surprise is the large decline in the quantity of imports within the petroleum group. The volume of import of crude oil products has fallen by over 46 percent, with a decline in July of 33 percent and as much as 71 percent in August. Clearly, the sales of petroleum products have tumbled in the country. However, the big fall in imports of crude oil implies that the output of refineries in the country will also decline sharply. Already, in July the output of petroleum products has fallen by 25 percent.
Another surprise is the fall of almost 10 percent on average in the volume of imported inputs for the textile industry. This does not auger well for growth in textile exports in coming months. Similarly, fertilizer imports are down and the reduction in its use will impact negatively on crop outputs in the Kharif season.
The 5 percent overall fall in the unit value index of imports is a reflection of the across the board fall in import prices, ranging from 2 percent in the case of the textile group to 15 percent in agricultural goods and chemicals imports. The only exception is the metal group with a rise in prices on average of 9 percent.
Why have import prices generally fallen? This is probably a reflection of the emerging recession in the world economy due to a visible fall in global trade, triggered off by the on-going US-China trade war. China has been compelled to reduce its export prices and given Pakistan's heavy dependence on China for its non-oil imports it has been a significant beneficiary of falling prices. Further, there is also the likelihood of greater under invoicing of imports.
Import-based tax revenues of FBR have apparently fallen significantly in July and August 2019. However, while the dollar value of imports has declined sharply, the rupee value of imports has continued to rise somewhat due to the devaluation. The increase recorded as such in the overall import tax base is 1 percent. However, the major part of import-related tax revenues is from the transport and petroleum groups. The rupee value of imports of these groups has fallen by 18 percent and 6 percent respectively.
There is a potential tradeoff in the stabilization process. Measures to reduce the trade deficit and thereby the current account deficit could lead to a rise in the fiscal deficit due to lower tax revenues. This will raise the level of aggregate demand in the economy and over time put pressure on imports and thereby lead to a larger trade deficit. Therefore, there is a need for striking a proper balance between trade, monetary and fiscal policies.
In conclusion, there is need to recognize the sharp curtailment in the current account deficit due to a big fall in the size of the trade deficit. Hopefully, the recent oil price shock will be only temporary in nature. If the fall in the current account deficit persists in the coming months of 2019-20 then there is a high likelihood that the balance of payments and reserves targets in the IMF Program will be fully met this year.
(The writer is Professor Emeritus at BNU and former Federal Minister)
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