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Closing the production gap

August 05, 2019

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As the dollar is becoming more expensive and scarce, the issue of import substitution is reverberating in public discourse on sagging investment. The spotlight on the topic has been prompted by the uncertain export outlook for the short to medium-term.

Liberalised imports funded by unsustainable foreign debts make no contribution to GDP while squeezing the fiscal space for balanced socio-economic development. And excessive imports have helped the service sector grow at a much faster pace at the cost of commodity-producing sectors.

Banks find it convenient to finance foreign trade rather than indulge in aggressive long-term risky lending for fixed industrial and agricultural investments. For well-known reasons non-performing bank loans, particularly of the manufacturing sector, have started rising and cash recoveries are slowing down as indicated by the data for the three quarters of 2018-2019. Borrowings by under-served credit sectors are subsidised by both federal and provincial governments but without any meaningful results.

Banks find it convenient to finance foreign trade rather than indulge in aggressive long-term risky lending for fixed industrial and agricultural investments

Given the level of country’s dollar earnings, it is now increasingly recognised that indigenous production should be boosted to reduce dependence on foreign goods, achieve self-sufficiency and create jobs. Trade experts say the import regime has to be reoriented to encourage savings and investment efforts on a much wider front.

Foreign exchange has to be used less, and more productively, and utilisation of domestic resources needs to be maximised. In the absence of a proactive import-substitution policy, past records show subdued imports in hard times bounce back as the economy returns to the growth trajectory to create yet another crisis.

To reduce trade deficit on a durable basis, import substitution has to be intensified particularly in capital goods and intermediate products like basic metals, chemicals, petroleum products, non-metallic minerals and food processing.

To quote an analyst “devaluation in the past made foreign goods expensive but failed to curb import-oriented economic growth.” He attributes the current sharp drop in import of machinery mainly to the completion of early harvest China Pakistan Economic Corridor energy projects.

In 2018-9, imports of agriculture/chemicals rose by 1 per cent to 16pc, oil and gas by 2pc to 26pc and classified other items went up from 8pc to 9pc of total imports. “If the government wants import substitution in targeted sectors,” he argues, “then these have to be fully supported with sound policies, tariff measures, affordable financing and private sector boosting measures. Never ending tariff and regulatory duties have not encouraged import substitution.”

Under the current bailout programme, the International Monetary Fund (IMF) expects Pakistan to do away with the levy of additional duties on inputs, intermediate goods and luxuries, a measure that is seen by analysts as the primary tool to restrict imports.

Successful import substitution policies adopted in the 1950s and 1960s were gradually abandoned in the 1980s and 1990s on the advice of the IMF and the World Bank in order to benefit from trade liberalisation and relaxation of capital controls. That delivered an import-oriented trade regime.

Globally, over 40pc of low-income countries are facing a high debt risk or are in a debt trap. “This has left limited room for policymaking with downward pressures coming from different directions,” says a noted scholar. The situation has worsened because the inflows of foreign direct investment in emerging markets, that provided a one-off balance of payment support, is also shrinking.

Some recent studies suggest that foreign firms which have significant domestic market share in certain items may be encouraged to set up production facilities wherever feasible. They could cater both to local demand and export markets and take local importers as joint venture partners, if possible. Investment should follow trade. This particularly would be relevant for investors from China whose goods have in recent years flooded the Pakistani market.

Though agriculture is the backbone of the country’s economy, food items account for a hefty 10pc share in total imports. That includes pulses, palm oil, soybean, dairy products etc from diverse sources such as US, Malaysia, Saudi Arabia, New Zealand and Australia. There is a huge unrealised production potential not only to reduce or eliminate these imports but boost exports of processed foods to the Middle East.

Foreign sales of food items virtually remain stagnant with marginal variations and dropped over the last financial year. It goes without saying that the trade deficit can be better managed by boosting diversified import substitution as well as export-oriented production.

The government needs to convince the country’s trading partners that Pakistan must be able to sell more goods and earn more foreign exchange to be enabled to import more of their products. Bilateral trade has to be gradually more or less balanced over the long-term.

And local entrepreneurs have to be encouraged to manufacture innovative products at competitive prices to get a stronger foothold in the export markets. That includes IT services or products.

But in the current phase of protectionism and faltering global economic growth, the first priority should go to import substitution. For that to happen, the Board of Investment may draw up and make public a tentative investment schedule with a brief profile of every prioritised project. And investment proposals should be supported by genuinely required initial incentives.

Published in Dawn, The Business and Finance Weekly, August 5th, 2019