Pakistan’s imports grew 44pc to $72 billion and exports by 28pc to $28.9bn during the first 11 months of 2021-22.—Dawn/File

Explaining Pakistan’s balance of payments crisis: A comparative analysis

A look at some of Pakistan's trade metrics in comparison with its regional peers.
Published April 19, 2023

Pakistan is in the midst of another economic crisis, negotiating yet another bailout package from the International Monetary Fund (IMF).

Bailout packages come with a large price tag as they increase the financial burden on the population through various measures. The government also attaches a promise of redemption on the tough road to recovery, terming the reforms a necessity to stabilise a tailspinning economy.

While some may point to the unending political crisis that has surely exacerbated our economic meltdown, the rot goes much deeper.

As we begin to understand why Pakistan has ended up in such a dire situation, while its regional peers are doing well, it is essential to study the country’s relationship with international trade.

The roots of the crisis

Foreign exchange reserves held by the State Bank of Pakistan dipped to $2.9 billion on 3rd February 2023 from a peak of $20.1 billion in August 2021. Such low levels of foreign exchange reserves raise alarm bells as investors and currency speculators fear imminent risk of an economic default. This has major implications on the currency exchange rate, which continues to depreciate.

The economic crisis in Pakistan takes its roots from the inability of the government to meet its external debt obligations, a problem that is directly linked to the country’s trade disequilibrium. Pakistan’s current account, which reflects the country’s net trade in goods and service and is an important component of the balance of payments, has consistently recorded large deficits over the years.

Considering data from the SBP, the current account deficit was at $17.4 billion in FY22. Imports outpaced exports by approximately $45 billion, with remittances, valued at $31.3 billion, softening the blow.

Clearly, one of the major reasons behind our economic crisis is this trade deficit as exports are worth only 45 per cent of imports.

There are several factors that can be listed for this imbalance, primary among which is a lack of efficiency across different markets, such as labor and capital markets. These inefficiencies mean Pakistani producers are unable to productively compete with foreign producers, particularly those located in the neighbouring Asian region.

Lack of industrialisation

A recently published report by the World Bank, “From Swimming in Sand to High and Sustainable Growth: A Roadmap to Reduce Distortions in the Allocation of Resources and Talent in the Pakistani Economy” highlights the lack of productivity in non-agricultural sectors.

This not only fuels our economic crisis but also discourages productivity-enhancing investments in the country. For instance, the capacity to generate exports has not increased in Pakistan relative to its peers, which reduces the ability of exporters to take advantage of a depreciating currency that should otherwise boost exports.

This lack of productivity, in turn, impacts the level of industrialisation and consequently the ability of Pakistani producers to compete in the world market.

Manufacturing value added (MVA) measures the contribution of the manufacturing sector to the GDP. United Nations Industrial Development Organisation (UNIDO) generally uses MVA per capita as a measure to determine the level of industrialisation in a country. Metrics such as MVA per capita and the exports of merchandise goods per capita gauge a country’s capacity to produce and export manufactured goods.

Given that manufactured goods constitute a large percentage of merchandise goods exported by several countries in the Asian region, the aforementioned indicators can be useful to determine industrial competitiveness. More productive producers located across countries, often a result of the combination of efficient markets and higher levels of industrialisation, are more likely to participate in international trading activities than their less productive counterparts.

The following analysis compares the level of industrial competitiveness between Pakistan and its major Asian counterparts. The countries included in the analysis are India and Bangladesh, the two largest economies in South Asia, and Vietnam and Cambodia.

Figure 1: Manufacturing Value Added per Capita in Selected Countries

The success story of Vietnam is widely known. However, Cambodia also has reported significant export growth in the previous decade. The analysis uses data on MVA, population, merchandise exports and imports from the World Development Indicators (WDI) and data on tariffs imposed on imports and exports, compiled by the World Bank’s World Integrated Trade Solution (WITS).

The manufacturing value added per capita for the selected countries is reported in Figure 1. Pakistan reported higher values than both Bangladesh and Cambodia in 2000 but lower values than India and Vietnam. However, it reported the lowest value amongst the five countries in 2021. Hence, the level of industrialization in Pakistan has reduced relative to that in Bangladesh and Cambodia.

Figure 2: Percentage growth in Manufacturing Value Added per Capita between 2000 and 2021 for Selected Countries

Percentage growth in MVA per capita between 2000 and 2021 for the selected countries is presented in Figure 2.

While Pakistan has only managed to double the value between 2000 and 2021, India has almost tripled it. Bangladesh, Cambodia and Vietnam have more than quadrupled it.

The lack of improvement in the level of industrialisation in Pakistan has its implications on the economy, particularly as the country faces a regular balance of payments crisis.

The trade perspective

Figure 3. Exports per capita of Selected Countries

Exports per capita of the selected countries are presented in Figure 3. While Bangladesh, Cambodia and India all reported a value of more than $260 in 2021, Pakistan reported a value of $122.

As the figure shows, Pakistan’s exports per capita in 2000 were higher than that of Bangladesh and India. The numbers for Vietnam have not been reported to keep the scale concise as Vietnam had surpassed $3000 in 2021.

Figure 4. Percentage growth in exports per capita for selected countries between 2000 and 2021

Percentage growth in exports per capita between 2000 and 2021 for the selected countries is presented in Figure 4.

While Vietnam saw a whopping 1,800 per cent increase in the last two decades, the growth rate for Pakistan is negligible in comparison, rising by 100 percent in the same period.

The other three countries have reported a minimum of 400 per cent growth in their exports per capita.

Figure 5. Percentage growth in exports per capita between 2000 and 2021 by region

The percentage growth in exports per capita between 2000 and 2021 for selected regions is presented in Figure 5. Pakistan performed below the regional average for sub-Saharan Africa, Latin America and the Caribbean. These regions have faced their own challenges that have limited their ability to improve their level of industrialisation, which has lagged other the Asian economies.

Figure 6. Imports per capita of selected countries

On the flip side, Pakistan also reports relatively low levels of imports per capita in comparison to its Asian counterparts. In essence, Pakistan’s exports per capita and imports per capita are low in comparison, indicating a lack of trade participation by Pakistani firms. This speaks volumes about their productive capacity and the ability of Pakistani businesses to compete in regional and global markets.

Import tariff rates

A major reason for Pakistan performing below its peers is the inability of Pakistani businesses to tap into the trade potential offered by its partners.

While the cost of doing business as well as barriers to trade are high in Pakistan due to inefficiencies in the various markets, the higher levels of tariffs imposed on Pakistani goods as well as the tariffs imposed by Pakistan on imports limit participation of Pakistani firms in international trading activities.

Figure 7. Source: Weighted Average Tariff Rates for Selected Countries .

The weighted average tariff rates on the import of goods into the selected countries is presented in Figure 7.

While all the selected countries lowered average tariff rates in the last two decades, Vietnam, Cambodia and India lowered them to a greater extent than Pakistan and Bangladesh. Vietnam has almost eliminated tariff rates on its imports, helping it integrate into global value chains.

Furthermore, Pakistan not only imposes prohibitively high tariff rates, exceeding 1,000 per cent on the import of certain products, it also has the highest number of tariff lines above 15 per cent. Bangladesh, on the other hand, follows a more uniform tariff policy across products with a maximum rate of 25 per cent in 2021. It consequently does not report any tariff lines for which the rate is three times above the simple average tariff rate.

Figure 8. Source: Import tariffs faced on exports of selected countries

The weighted average import tariffs faced by these countries on their exports is presented in Figure 8.

Pakistan reported one of the highest weighted average tariffs in 2000 and 2021. This is likely to add to the cost of trade from Pakistan, particularly as Pakistan exports low value-added goods that are sensitive to changes in their cost of production. Higher tariff rates are likely to discourage exporters.

Vietnam, which reported similar rates in 2000, was able to negotiate several agreements and lower the average tariff rates on its exports. ASEAN has proved to be a major game changer for Southeast Asian countries, helping boost their regional integration. Vietnam has 15 regional trade agreements (RTAs) in force, while India has 18. Pakistan, on the other hand, has 10 RTAs in force.

One of the biggest impediments of high import tariff rates, as well the lack of trade agreements, is that it discourages participation of producers in global value chains.

Southeast Asian countries have benefitted significantly from their participation in regional and global value chains as they have created well-established backward linkages with their trading partners. Imports are more efficiently converted into exports, contributing to value addition in the manufacturing sector. Low tariffs on imports and exports aid such linkages between trading partners.

Unfortunately, Pakistan continues to face challenges as policymakers have not been able to make strides in negotiating regional trade agreements in recent years. India, for instance, has recently negotiated a free trade agreement with the United Arab Emirates, while Vietnam has done so with the United Kingdom and the European Union.

What should be done

The government’s recent administrative controls on imports have hurt the capacity of the industry. The Business Confidence Index published by the SBP in collaboration with the Institute of Business Administration (IBA), Karachi, reports not only a fall in business confidence in the industrial sector but also a decline in capacity utilisation.

High tariffs and taxes coupled with import restrictions have decreased production capabilities. The delay in reaching the Staff Level Agreement (SLA) with the IMF is creating further challenges for the manufacturing sector, damaging its technical capabilities. The longer the import restrictions last, the bigger the impact on the already weakened trading relationships will be.

Tariffs act as a burden on both exports and imports and reduce the ability to participate in regional and global value chains. They make Pakistani producers inward looking and reduce their desire to improve their level of competitiveness as they remain protected from competition.

Initiatives such as Pakistan Single Window that reduce trade costs are crucial. In addition, policymakers must not only address the lack of trade agreements, which have locked out domestic producers from foreign markets, but also improve the quality of trade missions abroad.

The decline in industrial competitiveness in the last two decades is alarming.

It is imperative that steps are taken to reverse this trend. The lack of industrialisation and the lack of trade participation by Pakistan has implications for the overall economic health of the country.