WHEN Imran Khan took over as prime minister in August 2018, Pakistan’s economy was facing a twin-deficit crisis: the country was haemorrhaging foreign reserves while the fiscal deficit was burgeoning. Placing the economy into the proverbial intensive care unit — an IMF programme — was the only option. Two years on, the prime minister is celebrating a current account surplus of $424 million in July 2020, hailing that the “economy is on the right track”.
In these two years, the PTI’s narrative has shifted from its opposition days. Gone is the mantra that debts are bad for the economy, which makes sense given that Rs11.2 trillion has been added to the debt burden in the last two years. Today, the focus is on the current account but by doing so, the ruling party is yet again repeating its past mistake of using one economic indicator to bolster its economic narrative.
In simple terms, the current account represents the difference in exports of goods and services and imports of goods and services, with transfers from abroad, such as foreign aid and remittances, being included. A negative figure means that the country owes money to the rest of the world that needs to be paid back. While these payments can be made in the future by borrowing today, eventually, the loans and interest has to be paid back (except when it defaults, which is a different story).
Developing countries often run current account deficits to build their production capacity and improve productivity. This often occurs by importing machinery from abroad, which is what Pakistan did in the last few years. Faced with a crippling power crisis, the PML-N engaged China, operationalised CPEC, and built large infrastructure projects, including power plants and highways. The result: Pakistan ended up with surplus power, new highways, increased debt, and a yawning current account deficit.
The underlying issue with the economy remains in place.
During that same period, a flawed policy of keeping an overvalued exchange rate meant that imports were cheaper — good if you are importing machinery — and exports became relatively more expensive — bad if you are an exporter. The result was that while imports continued to mount, exporters found it hard to compete. To bridge the gap, Pakistan borrowed money from international markets. Eventually, this gap became unsustainable, just as the PTI came to power in August 2018.
Yet another IMF programme became a necessity and the economy was put in coma to save the patient. Interest rates were raised, the currency devalued, inflation spiked, the economy went into a recession, and yes, the current account deficit narrowed and is now in surplus.
But look a little closer and you will see that this decline in the deficit is largely driven by a decline in the imports of two key items. From July-June 2018 to July-June 2020, Pakistan’s imports of goods declined by nearly $13.5bn (24.7 per cent); $6.6bn (49pc of the total) came from machinery and petroleum imports. The former is driven by an end to CPEC-related projects and the latter by a decline in global energy prices. During the same period, exports of goods declined by $1.8bn (7.4pc); $1.8bn (33pc) was due to a decline in textile exports.
This shows that the underlying issue with Pakistan’s economy, ie the country’s inability to export more goods and services to the rest of the world, remains in place. With machinery imports declining, capital investments that can make the economy more productive are being delayed. Given that Pakistan is an energy-importing country, it continues to be exposed to the risk of a current account shock should energy prices rebound.
Then there are other indicators worth paying attention to. As I wrote earlier, persistently high inflation is reducing the real purchasing power of Pakistani households. This has a two-fold effect: it softens demand in the economy as households struggle to balance their budgets and it reduces savings. The latter means that domestic savings fall, eroding the economy’s ability to finance necessary investments through domestic savings and thereby increasing the need for foreign borrowing to fund needed investments.
Private-sector credit uptake also indicates weak economic fundamentals: despite a decline in interest rates, private-sector credit came in at negative Rs110bn in July this year; in FY2020, banks lent Rs196bn compared to Rs 693bn in FY2019.
The uptick in remittances has helped improve the situation. But this uptick may be short-lived as constrained growth in the GCC, EU, and the US erodes the diaspora’s ability to continuously send money to their families.
Celebrating the current account surplus is akin to celebrating a gangrene-ridden diabetic’s successful surgery. The economy has a long, tortuous path ahead and without meaningful reforms, an uptick in growth and/or energy prices will again raise the spectre of a mounting current account deficit.
The writer is a senior fellow at The Atlantic Council and host of the podcast Pakistonomy.
Published in Dawn, September 2nd, 2020