Besides, estimating the long-run relation, it is also necessary to measure the contribution of imports as it has significant implications on trade balance. In this respect, measuring the content of imports in exports, is of great interest.
Pakistan provides an opportunity to investigate these issues as its trade deficit, in term of GDP, has increased sharply in the recent years (from 2.4 in FY00 to 5.6 per cent in FY05) mainly due to a surge in capital and intermediate imports.
The growth in import has overshadowed the reasonable export performance. In view of the rising trend of capital and intermediate imports, the recent export performance raises an important economic question: how much of the export growth is an outcome of the higher imports?
This paper estimates the actual contribution of imports in the total export growth over the review period 1973-2005. It is also important to investigate the economic hypothesis that the upward trend in trade deficit might be of transitory nature and not permanent. In other words, the desirability of trade deficit is based on the assumption that the surge in imports will result in higher exportable surplus, resulting in lower trade deficit in future years.
The result shows that the imported inputs have a significant role in the overall export performance. The contribution of imported inputs in the total export level is 37 per cent. However, this impact would translate with a period lag. This paper also provides the disaggregated long-run estimates of imports which are 24 per cent for raw material and 16 per cent for capital goods.
Trade structure and policies: Pakistan inherited a weak industrial base. Initially, the government adopted an ‘import substitution industrialisation’ (ISI) strategy. The main objective was to replace the domestic demand for imported consumer goods by domestically produced goods with more emphasis on encouraging import of capital goods and raw material by relaxing restrictions.
Important measures taken to liberalise imports of raw material were: (i) introduction of a ‘free list’ for raw material imports; (ii) expanding licensable imports list; and, (iii) simplifying procedures of import licensing. As a result of these policies, the share of consumer goods in total imports dropped from 30 per cent in 1960-61 to 16 per cent in 1969-70. While the share of capital and intermediate goods in total imports increased from 71 percent to 84 per cent.
To encourage exports, the government introduced the ‘Export Bonus Scheme’ (EBS) in the first half of 1960s, to support the exporters of manufactured goods through more favorable exchange rates. Similarly, the government maintained its policy stance for the promotion of export in later half of the decade in the form of issuance of ‘export performance license’ during 1968. The share of manufactures in total exports recorded a sharp rise from 39 per cent in 1960-61 to 67 per cent in 1970-71.
During the decade of the 1970s, trade policy continued towards import liberalisation and export promotion. The main focus of the import policy was to eliminate administrative controls adversely affecting exports. The distinctions between industrial and commercial importers were removed, import of capital goods under the free list was permitted, and extensions were made in the list of raw material.
On the export side, when the ‘export refinance scheme’ (ERS) was introduced by the State Bank of Pakistan, adjustments were made in export duties on a number of items, tax exemption and rebate on excise and custom duties were also allowed to exporters. In addition, after the devaluation of the rupee by 10 per cent in 1973, exchange rate was pegged to the dollar at Rs9.90.
Despite these measures to encourage exports, trade pattern experienced a shift in the form of lower exports and rising import bills of capital and raw material since the 1970s. Resultantly, the economy faced a large trade deficit (Figure 1) Source: Federal Bureau of Statistics, Islamabad
Despite the official incentives, some exogenous factors adversely affected the export growth. Specifically, there was an increase in international oil price which led to recession in the international market. The domestic drctor suffered from erratic agricultural performance. Exports fell to an average of seven per cent of GDP in 1976-80 from an average of 8.1 per cent of GDP during 1972-75. While imports to GDP ratio increased to an average of 14.1 percent from an average of 10.9 per cent of GDP. (Figure 1).
During the 1980s, there was a shift in trade policies globally from ISI to export led growth (ELG). Pakistan continued its liberalisation policies towards more export oriented industries. The conversion of fixed into flexible exchange rate, duty free imports of essential machinery and raw material to certain export-industries, and the export rebates proved to be major factors of export growth.
Other main export incentives included: (i) compensatory rebates scheme; (ii) export credit guarantee scheme; and (iii) concessionary credit for exporters.
During the second half of the 1980s, for the promotion of textile industry, the duty-free imports of machinery for balancing, modernisation and replacement (BMR) purpose were allowed. Various steps for liberalising imports included abolishment of the system of free and banned imports in 1983 and the introduction of a negative list items. As a result, the share of manufacturing and semi-manufacturing in total exports rose sharply (that is, 58 in 1979-80 to 80 per cent during 1989-90). This policy led to the acceleration of import growth and, the share of intermediate and capital goods in total imports which was 78 per cent in 1978-79 increased to 86 per cent during 1987-88.
The pace of trade liberalisation was accelerated under a structural adjustment programme (SAP) with the IMF in 1988. In case of imports, the government removed the non-tariff barriers (NTB) and replaced them with tariffs measures, accompanied by reduction in maximum tariff rate. For export promotion, the programme decided to change the previous system of uniform income tax rebate to encourage value addition in exports.
The data on trade shows that in early 1990s, imports rose steeply primarily due to the continued import liberalisation policies together with the international oil price shocks. For further imports liberalisation, restriction on import license scheme (except for commodities on the negative list) was abolished. All authorised dealers were allowed open letter of credit for imports, and importers were granted permission to use foreign exchange without any ceiling.
Moreover, trade policy during FY00-05 was primarily focused on increasing the trade openness and industrial growth. The government provided incentives for reducing the cost of doing business for attaining competitiveness. It also made efforts to increase and diversify the export base by exploring untapped markets for both traditional and non-traditional items.
In the recent past, the government took important measures to promote trade activities such as: (i) restriction on importing more than five-year old machinery was abolished; (ii) maximum tariff rate reduced to 25 per cent (Figure 2); (iii) Pakistan export finance guarantee agency has been set up in the private sector to facilitate small and medium enterprises for working capital requirement;
Source: Central Board of Revenue, Islamabad
Due to these policy initiatives, imports, particularly of capital and raw material goods, grew very rapidly since the early 1970s. While the acceleration in the export growth after 1985 was mainly a reflection of the change in exchange rate regime in 1982. The upward movement in imports, to some extent, sustained during the first half of the 90s resulted into persistent level of trade deficit.
In the recent years, imports again accelerated sharply primarily due to large oil import bills together with capital imports, while the exports also showed a remarkable growth.
Contribution of imports in domestic production: The input-output tables developed by the Federal Bureau of Statistic (FBS) are not available after 1989-90. We used the share of imported inputs in total value of domestic production, based on the census of manufacturing industries, as a proxy for measuring the import content in total exports.
Table 1 suggests that during different sample periods, on average, the imported inputs contributed approximately 18 per cent share in the total value of domestic production. The disaggregated contribution of imported inputs for different industries reflects the highest ratio for machinery and equipments and chemicals which is 30 and 35 per cent respectively in 2000-01.
The brief review of trade polices and statistical analysis raises two questions: (i) whether the fluctuations between exports and imports have some relation in the long run, and, (ii) what is the elasticity coefficient of total as well as the disaggregated imported inputs (raw material and capital goods) in total exports?
Impact of disaggregated imports: The average elasticity of raw material and capital imports is nearly 20 per cent. At the disaggregated level, the results depict that one per cent rise in import of raw material will have a significant positive impact on exports of the same period, which is 0.24 per cent. The elasticity of exports with respect to capital goods is 0.16 with one period lag. These elasticities reflect that the imports of raw materials have a stronger impact on the exports relative to capital imports.
The rationale for the stronger impact of raw material towards export lies in the fact that Pakistan’s major exporting sector (textile) largely use raw material such as yarn, textile fibre, and pure telethelic acid (PTA) as an input in producing final goods.
However, capital goods are mainly used to enhance the productive capacity of both the export and non-export sectors of the economy. This is probably due to the fact that there are few items classified under capital goods, such as power generating machinery, telecommunication and sound recording equipments, road and motor vehicles, office machinery, construction and mining machinery (having approximately 38.9 per cent share in capital goods),which are largely imports for domestic production only.
In addition, durable goods like mobile phone, handsets, cars, telephone sets, television and refrigerators and other consumer durables, are wrongly categorised as capital goods.
However, they have a significant share (approximately 18 per cent) in total capital goods; thus, explaining the low elasticity of capital imports. If we define the capital imports in terms of those goods which are directly used for export production, the elasticity of capital imports would be higher than what we have obtained.
Conclusion: The objective of this paper was to examine and estimate the long-run dynamics of the real exports and imports. This paper developed a semi-reduced export equation that takes into account the impact of imports on exports.
The empirical evidence suggests that the long-run elasticity of exports with respect to imports is 37 per cent; however, the effect appears with a lag. At disaggregated level, the contribution of raw material and capital goods in total export performance is 24 and 16 per cent respectively.
Despite the fact that the empirical result indicates that there is a tendency among the real trade variables to co-integrate in the long-run. There are some sources of concern as the contribution of total imports in export is not fairly large given the considerable deterioration in the country’s trade balance emanating mainly from the import side.
The results, however, depict that the import of raw material and capital goods have an important role in boosting the overall export level; whereas, the exports are more sensitive to import of raw material rather than capital imports.
Because of inappropriate recording of several items in capital goods, the estimated elasticity of capital goods is biased downward. Despite all these data limitations, the elasticity coefficient of capital goods reflects that by increasing the capital imports for those exporting industries which have a potential to export but due to capacity constraints are unable to do so, we can increase the export level.
This study also indicates that in medium to long-run, it is the structure of imports, particularly capital and raw materials, which should be monitored closely. It will help the policy-makers to focus on importing more of those items which are directly used into export production, thereby increasing the export capacity reducing the excess pressure on trade imbalances.
On the face of burgeoning trade deficit, there is a need to analyse the different policy options to control trade imbalances. Restricting imports through tariff measures might not be desirable given the country’s obligation under WTO commitments. Thus, any slowdown in trade imbalance could only be achieved through appropriate exchange rate and interest rate policies. However, what is equally important for the policy-makers is not to significantly weaken the on-going growth momentum.
(The edited extracts of State Bank working paper represents personal views of the author, an analyst at the SBP).