The quality of the C/A deficit cut

Published July 20, 2020
The narrowing of the C/A deficit means that the short-term health of the external sector did improve.
The narrowing of the C/A deficit means that the short-term health of the external sector did improve.

IN the first 11 months of 2019-20, Pakistan’s current account (C/A) deficit shrank to $3.28 billion from $12.45bn a year ago. But the overall balance of payments (BoP) that was surplus in the same period of 2018-19 recorded a deficit of $3.44bn, according to the State Bank of Pakistan (SBP).

If we look at the two sets of numbers together, we can easily understand Pakistan’s external sector is still in problem. But the government’s economic managers and Prime Minister Imran Khan prefer to talk exclusively about the narrowing of the C/A deficit. Looking at just the C/A deficit could be misleading if one overlooks the factors that contributed to the reduction in the deficit. The fact that Pakistan’s BoP went into red in 2019-20 means the holes in the entire external sector could not be filled in despite borrowing from the International Monetary Fund (IMF) and the state-level and commercial funding from China, Saudi Arabia and the United Arab Emirates.

But the narrowing of the C/A deficit means that the short-term health of the external sector did improve. Taking care of the C/A deficit but allowing the BoP to go into red at the same time makes sense. There was an urgent need for fixing the short-term issues in the external sector because they affect our exchange rates more directly and almost immediately. Besides, had the country not taken a hit on the BoP, it could not have maintained foreign exchange reserves at the minimum desired level. And that, in turn, could have affected exchange rates again.

Are economic managers confident that exports that did not grow in the last fiscal year will start increasing now? Only in that case will the reduction in the foreign trade deficit be of better quality

However, one must look closely at what contributed to a remarkable reduction in the C/A deficit. Without that, it will be difficult to form an informed opinion about its quality and sustainability.

Foreign trade in goods on the free-on-board (FOB) value, foreign trade in services and remittances hold the key to managing the current account. Which means the merchandise trade and services trade deficits falling and remittances increasing can help immensely, though not entirely, in managing this account. The quality of the C/A balance improvement via foreign trade account depends on whether the trade deficit of goods and services has occurred owing to an increase in exports or a decrease in imports. Or if a combination of the two has been recorded that has played a greater part in the reduction of the C/A deficit — increase in exports or decrease in imports. A reduction in the foreign trade deficit of goods and services owing to an increase in exports is considered qualitatively better and more sustainable. But sadly this has not been the case. In July-May of 2019-20, exports of goods rather declined to $20.94bn from $22.46bn. And exports of services, too, fell to $5.05bn from $5.52bn.

Remittances did increase but not by much. Inflows in the 11-month period totalled $20.65bn against $20.104bn in July-May a year ago. So what actually helped Pakistan see a massive contraction in its C/A deficit? Primarily, a massive cut in the imports of goods (on FOB value) as well as imports of services. Merchandise imports in that period shrank to $38.88bn from $47.83bn a year back. Imports of services also narrowed to $7.75bn from $10.146bn over the same period.

The government says GDP contracted 0.4 per cent in the last fiscal year and has set a 2pc growth target for the current year. If the economy starts growing as anticipated by the government, it will grow with the increase in imports.

But are the economic managers confident that exports of goods and services that did not grow in the last fiscal year will increase — and at a faster rate than imports? If this turns out to be the case, the reduction in the foreign trade deficit and eventually in the C/A deficit will hopefully be of better quality. If not, managing the current account on a sustainable basis can become a big headache.

On the remittances front, things are not as rosy as the government is trying to make us believe just on the basis of a huge growth in June, the last month of 2019-20. In June, remittances shot up to a record $2.46bn from $1.63bn in the same month last year. Although welcome news, the one-time rise in remittances merits some scrutiny. It has come at a time when hundreds of thousands of Pakistanis in the Gulf region have lost jobs and returned home or are waiting to return home. This means some of the sources of the remittances’ flow are going to be closed forever.

Similarly, cumulative flows of a few months have also come in June from the Gulf region and elsewhere after Pakistani workers there had to hold part of their earnings for consumption in Covid-19–triggered lockdowns in their host countries. Besides, Eidul Azha in Pakistan is due on July 31. Overseas Pakistanis normally start sending larger remittances back home a month or two ahead of it. Eid-related remittances can hopefully keep the inflows thick even during July. But August onwards, our economic managers will be able to make a more realistic projection of remittances keeping in view key factors like the continuation of layoffs in the Gulf region, United States, United Kingdom and Malaysia amid a global recession and falling exports of manpower from Pakistan.

Last year, 625,203 Pakistanis went on work visas to different countries. But in January-June this year, the number of people going abroad for work slumped to 177,316. Given the current global economic situation, even the most optimistic person cannot hope for the full-year number to come close to that of 2019.

Published in Dawn, The Business and Finance Weekly, July 20th, 2020

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