Deficits and reserves

15 Jun 2017

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THIS week, the trade deficit crossed $30 billion, probably the most meaningful milestone crossed recently. Certainly more so than any ‘historic high’ hit by the stock market of the foreign exchange reserves.

For now, the government is in denial mode over this development, thinking that a few incentive packages should be enough to turn the tide, and given that this is an election year, the room for it to awaken to the dangers that this development poses is limited.

Adding to the complication on the trade front is the growing gap between import data as reported by the State Bank and the Pakistan Bureau of Statistics (PBS). The problem came to light when people began to notice the discrepancies late in 2016, and then the State Bank flagged the problem in its last quarterly report. The discrepancy was due to imports from China, said the State Bank.

Apparently, money borrowed from Chinese banks to pay for machinery imports was not coming to Pakistan; it was being used directly in China to make payments, so when the machinery landed at the port and went through customs valuation, it showed up in PBS data but the State Bank could not see any outgoing payment for it.

In the latest data series, the discrepancy has climbed to almost $6bn in the July to April figures.

Some hardened souls tried to suggest that this is normal because the equipment is being purchased on supplier credit. Not so. Supplier credit is reported to the State Bank where it is booked as an outflow because the central bank needs a complete picture of all outflows, whether being booked as a payment or as a future payment. A large sprawling exercise to reconcile the figures from data provided by banks was launched around that time, but that exercise is proving to be more complicated than at first imagined. It has yet to be completed.

The real trade deficit is likely to be higher than what is currently being reported

So the real trade deficit is likely to be higher than what is currently being reported, and if you include under-invoicing of imports, the figure will be higher still.

The only relief in sight for the government is if oil prices fall, which is a possibility but unlikely to compensate for the growing deficit. Only a portion of the increase in imports can be explained as one-off machinery imports, as the government is trying to do. Oil accounts for a substantial amount of the increase, even though its price has not increased by that much since July, meaning quantities are increasing.

Reserves have declined by $3bn since last July, a decline of 13pc, with almost all of that decline coming from State Bank reserves (as opposed to reserves held by commercial banks). As debt servicing is set to mount in the years ahead, this decline could accelerate.

The government has budgeted external borrowing of almost $8bn for next year, with the bulk of that coming from China, followed by the Islamic Development Bank, the World Bank and a billion dollars each from Sukkuk bonds and commercial bank borrowing.

Last year, they had set a similar target, but overshot it by almost $2bn, and borrowing from commercial banks accounted for all of this.

The country’s external sector is softening, its debt profile is weakening while the exchange rate is steady and the government’s entire focus is now on surviving the immediate political challenges to its rule, followed up by the approaching election.

This means whatever forceful measures might be required to arrest this deterioration are unlikely to be taken at this point, the matter being left to the next government, by when the deterioration will be far more advanced.

It doesn’t take a lot to see where this is going: back to the IMF, but not for another few years. It is difficult to say how long this moment of comfort can last with the ground shifting from beneath it all. But by the end of 2018, we should be getting there if something drastic has not happened in the meantime, such as an unusual spike in remittances or an unusual fall in oil prices, or a dramatic plunge in total imports as CPEC machinery is installed and commissioned.

We shouldn’t rule any of those out, but we shouldn’t peg the fortunes of our external sector on hopes of this sort either.

So the question to ask is what happens when we get to that moment again? Historically, that moment or depleted reserves has taken us back to the IMF, and for the past 10 years our relationship with America has served as a bit of a lever with which to extract advantageous terms without having to come through on the reforms that usually accompany these programmes.

There was a short interruption in this pattern in 2011, when our relationship with America was in the doldrums, resulting in a rupture with the IMF as well. But that moment was short-lived.

The only way to avoid going back to the IMF would be if the Chinese were willing to bail us out, but thus far the Chinese have made clear that they are not in the business of bailing anyone out. This will not be a request for more project financing. It will be a request for balance-of-payments support, which may or may not be forthcoming.

But on the flip side, the Chinese will need to weigh what it will mean for their investments in Pakistan if the country were to go on a Fund programme, with all its attendant slashing of government expenditures, and serious reductions in the growth rate of the economy as stabilisation measures kick in.

It’s possible they could seek ways to insulate their own enterprises from the impact of the stabilisation, or they could discover that seasons change fast in this country. It could be an interesting, and revealing, moment that this deterioration in our external position is carrying us towards.

The writer is a member of staff.

khurram.husain@gmail.com

Twitter: @khurramhusain

Published in Dawn, June 15th, 2017