Current account deficit (CAD) is often associated with the sustainability of foreign debt and in that aspect, it is used as a barometer of economic outlook by investors and policymakers. Pakistan has a long history of running a current account deficit with short-lived periods of surplus like 1982-83, 2000-2003, and most recently in the first two quarters of 2021.
The Pakistan Tehreek-e-Insaf’s (PTI) focused on current account surplus (CAS) and celebrated it as a milestone in the history of Pakistan. However, with negative GDP growth, current account surplus can’t be because of the significant increase in exports that can result in export-led growth, rather it can be due to some other factors.
During the first two years of the PTI government, Pakistan exports decreased substantially by 23% in the 4th quarter of 2020 compared to the first quarter of 2018 as shown in figure 1. However, with rapid currency devaluation from 108 to 160 PKR per US$ (from Jan-2018 to Jan-2021), exports boost was expected but that did not happen. Furthermore, the import bill decreased by 32% in the 4th quarter of 2020 as compared to the first quarter of 2018.
Hence during the earlier two years of the PTI government, exports, as well as imports, decreased in conjunction with massive currency devaluation. This raised question that why the exports do not respond to currency devaluation? There could be many reasons, but the main reason is tight monetary policy and heavy taxes introduced by the government which as a result discouraged investors.
From May 2018 to March 2020, the State Bank of Pakistan (SBP) increased the policy rate from 6.5% to 13.25% to control inflation and to attract foreign savings, which negatively affected the domestic economy. Furthermore, under the instruction of the IMF extended fund facility government has cut subsidies and increased energy prices, which worsen the situation.
In response to the Covid-19 and poor economic activity, SBP has cut the policy rate which is now stable at 7%. If we look at CAD, it increased substantially in the fourth quarter of 2018 and reached US$6141 million as shown in figure 2 but it improved a bit in later periods. Recently, in the first two-quarters of 2021 Pakistan experienced CAS.
However, according to SBP improvement in CAD is mainly driven by the decrease in import bills in response to a decrease in oil prices internationally and due to an increase in foreign remittances. Foreign remittances have been increased substantially after the third quarter of 2019. In the third quarter of 2019 remittances were US$5044 million while in the first quarter of 2021, it increased to US$7147 which is 53% higher compared to the first quarter of 2018.
In FY21 worker’s remittances are $29.4 billion as compared to $23.1 billion in FY20 as shown in figure 3. The historical high inflows of workers’ remittances have been driven by proactive policy measures by the Government and SBP to incentivize the use of formal channels, restricted cross-border travel in the wake of COVID-19, and orderly foreign exchange market conditions.
Moreover, the imports decrease substantially from US$ 18313 million (FY18- Q4) to US$ 11091 million (FY20-Q4). However, in the fourth quarter of 2021, Pakistan CAD reached to US$ 2457 million which is mainly driven by an increase in imports. As imports increased from US$ 11091 (FY20-Q4) to US$ 18231 million (FY21-Q4). Hence, it is evident that the improvement in the current account in the first two quarters of 2021 was not because of the substantial increase in exports but due to foreign remittances and a decrease in oil prices.
If we look at history, Pakistan CAD is heavily financed by foreign remittances and foreign aid. During Zia’s regime, the CAD crossed 5% of GDP which was alarming. Furthermore, the trade deficit was also high, for most of the time it remained greater than 10% of GDP. However, in 1982-83, Pakistan’s current account became surplus as shown in figure 4.
The main reason behind the improvement of CAD was the increase in foreign remittances along with American aid to support the war against the Soviet Union in Afghanistan. As a result, Pakistan experienced a high growth rate (on average 6-7% during Zia’s regime). Further, denationalization policies also improved economic activity, whereas foreign remittances also helped to finance the trade deficit.
After Zia’s regime, in 1988 government rolled into the hands of the Pakistan People’s Party (PPP) and Pakistan Muslim League- Nawaz (PML-N) two largest political parties-, but none of them could complete their tenures. This era can be classified as -musical chair government(s). It is interesting to note that in the 1990s trade deficit shrank as well as the flow of foreign remittances also remained low compared to Zia’s regime. On other hand, CAD crossed three times the limit of 5% of GDP and in 1995-96 which reached 7.1% of GDP. The most interesting case of Pakistan history is the Musharraf’s era (1999-2007) -also known as “enlightened moderation”.
Pakistan enjoyed both flavours, CAS during 2000-2003 and later on the deficit and crossed 5% of GDP in 2006-07. During this period, trade balance, as well as foreign remittances, improved significantly. Furthermore, due to the political stability foreign direct investment increased. However, foreign flows are mainly concentrated on consumption-related goods instead of more technology-intensive production. Similarly, Pakistan shifted its focus from the agriculture or industry sector to the services sector. Pakistan also received extensive funding in support of the War Against Terror, but the government didn’t channel it properly.
The government encouraged consumption hence import demands increased substantially. During 2003-08 exports grew by an average of 13.3% per annum, whereas imports grew by 23% per annum which raised the trade deficit from 25.8% to 35.5% of GDP in 2006. Economic activity was mainly driven by the demand for durables, which mainly concentrate around the telecom and the financial sector. This led to massive imports of cellular phones with the rapid increase in oil prices and hence accumulated CAD.
When the PPP took over the government in 2008, CAD reached 9.2% of GDP in its first year, which was the highest CAD in the history of Pakistan. Later on, due to the rise in foreign remittances, the current account balance improved. Similarly, in the PML-N government foreign remittances remained high along with trade deficit which mainly comprised of imports of machinery related to CPEC.
An important question which shall not be condoned is that whether the CAD is good or bad? The answer is hidden in its composition. In the case of Pakistan, CAD is mainly driven by consumption-related imports.
Furthermore, exports are low and based on highly elastic -low technology-intensive products, for this reason, we are losing our competitiveness in the international market.
Moreover, government reliance on foreign aid and borrowing from IMF along with conditionalities also worsen the situation and discourages investment, as we have observed in the first two years of the PTI government. This has also happened in the past during previous governments, yet, in terms of structural adjustment programs, there has not been much progress made.
Concomitantly, if necessary, measures are not taken to support agriculture and industrial sector, we cannot improve trade balance and hence current account balance. Nevertheless, the addiction to the IMF and bowing to its strict conditionalities will continue to cause CAD in the foreseeable future. In a nutshell, “There is no hope with IMF”.
(Dr Uzma Bashir. Pakistan Institute of Development Economics, Islamabad. Email: uzma.economist@gmail.com)
