In fact we are able to meet one-third of our oil requirement from local production and in many years we have been importing wheat. The structural tendency of current account deficit in our economy has re-asserted with a bang in FY 05 when we had a current account deficit of $5 billion. Current account deficit (CAD) of FY 06 will be much higher than last year’s figure, because the CAD of July-September 2006 is $2.6 billion against last year’s figure of $1.6 billion in the same period. This has raised alarm bells in Washington and in Pakistan. Both IMF and World Bank have advised the government to devalue the currency by at least 10 percent.
It would be essential to analyse as to how the CAD which was in surplus for three successive years (FY 02 to FY 04) has deteriorated so sharply in FY 05 and FY 06. One of the main reasons is the high rate of inflation in FY 05 and FY 06 as compared to three earlier years. The average rate of inflation during FY 02 to FY 04 was 3.7 per cent whereas in the years of current account deficits it is 9.3 per cent in FY 05 and 7.6 in FY 06 and in FY 07 it is running at eight per cent. If rate of inflation in the current year is eight per cent as estimated, then the price level would have increased by 26 per cent during three years ending June 2007.
Inflation increases the cost of inputs for all industries including export industries. If during these three years, the exchange rate has remained more or less stable and the domestic price level has risen by 26 per cent, the cost of inputs will definitely increase and this will result in drop in exports.
The utility prices in Pakistan are highest in Asia, according to a World Bank study. They are almost 30 to 50 per cent higher than the economies which compete with our exports like India, Bangladesh and China. It is very interesting that IMF is advising us to devalue and at the same time, hike the electricity tariff. Whatever favourable impact devaluation may have on exports will be neutralised by spurt in electricity rates. We must give our exporters electricity at the same rates at which their competitors are getting because energy cost is almost 20 to 25 per cent of the total cost in any industry.
In theory, devaluation has a favourable impact on the CAD if the quantity of exports increases as a result of export products becoming cheaper in foreign exchange. This situation does not prevail as we have very low price elasticity for supply of exports. Pakistan devalued its currency from Rs22.4 in 1991 to Rs51.8 in FY 00. But our exports only increased from $6.1 billion in FY 1991 to $8.6 billion in FY 2000 giving an average rate exports growth of less than five per cent. Hence, devaluation did not provide any spur to exports. Devaluation as before will further stoke the fires of inflation and retard exports because the cost of many inputs used in the export industry are imported. The current account deficit in FY 05-06 has been caused by stagnation in exports and ballooning of imports. In July-November 2006, total exports have increased by only five per cent where as textile exports have fallen by one per cent.
The decline in textile exports which account for 60 per cent of Pakistan’s total exports is a matter of concern. According to all analysts domestic and foreign, there is no international recession in textile and clothing market. Previously Pakistan had a quota in major markets of USA and EU. The textile quotas have been abolished since January 2005 and Pakistan’s poor competitiveness has been exposed in the quota free world. India, China and Bangladesh have gained from the abolition of quotas. Our inability to compete entirely stems from input cost hike, according to IMF and domestic producers and exporters of textile. Besides higher input costs our labour force is not trained, our managerial skills are deficient, and our internal freight rates are high. None of these negative factors will be cured by devaluation.
The imports have surged by 32 per cent in FY 06. Petroleum group has obviously contributed in a large measure towards spike in imports. However, petroleum group account for only 30 per cent for the increase in imports in FY 06. Other major contributors are machinery, raw materials, and consumer durables. In this regard it must be pointed out that with high rate of GDP growth of 8.6 in FY 05 and 6.6 in FY 06 has increased the propensity to import. The growth in private consumption expenditure which had fallen from two per cent in FY 01 to 0.5 per cent in FY 03 increased by 11.5 per cent in FY 04 and 13.5 per cent in FY 05. There is a consumer boom which has led to high consumption of imported goods.
A reverse of import substitution is taking place because instead of substituting domestic products for foreign goods, we are discarding domestic items in favour of foreign merchandise. The prices of domestic goods have increased because of inflation whereas prices of imported goods have remained the same because of stable exchange rate or have fallen because of lowering of tariffs. The present consumer boom is facilitated by consumer credit which has risen by billions. Personal loans by scheduled banks which were less than Rs10 billion in FY 01 have increased to Rs90 billion in FY 05. Therefore the hike in imports is not only due to POL prices but also stems from consumer boom fed by high GDP growth, low prices of quality imported goods as compared to high priced inferior quality domestic goods and mountain high personal loans given by the banks.
Our foreign office is only concerned with showing Pakistan as the front runner in the war on terror and trying to placate India and Afghanistan and that too unsuccessfully. We have no economic diplomacy. USA has signed free trade agreements with Morocco, Jordan and many other countries whereas Pakistan which is non-NATO ally has only been promised duty free imports from special opportunity zones (SOZs) which comprises tribal areas and earthquake stricken zones. No exports are produced in these zones; hence, significance of this concession is zero. We need to press US given our security and economic situation to give us free market access as it has given to Morocco and Jordan. Similarly, EU gave us duty free access for three years from 2002 to 2004. But this concession has now been withdrawn and the geographical analysis of the decline in our textile exports shows that major fall has been in the EU market. The textile exports of Bangladesh being a least developed country enter EU without any duty. Pakistan needs to be given a concession as it was given in earlier years by EU. Similarly we have failed to energise Islamic free trade area and ECO free trade area or sign bilateral free trade agreements with countries with good export prospects. We have signed FTA with China but it is not likely to provide a boost to our exports. Saudi Arabia has not resumed the Saudi Oil Facility despite our critical foreign exchange situation. The foreign policy of a developing country like Pakistan facing a huge current account deficit should concentrate on economic issues rather than insoluble political issues.
The Governor of State Bank of Pakistan deserves all the kudos and plaudits for clearly telling the IMF and the World Bank that devaluation will not help in solving our current account deficit but may aggravate it. The public in Pakistan and foreign traders also deserve accolades for holding the rupee value steady despite speculation engendered by imprudent behaviour of IMF and World Bank. At the same time the rate of inflation must be brought below five per cent by a new comprehensive strategy to reduce domestic consumption. Pakistan’s high GDP growth has been accompanied by intolerably high rate of inflation whereas in India and China the GDP growth rates are higher (eight per cent and 10 per cent) and the rates of inflation in India and China are less than five per cent and three per cent.
It would be highly imprudent and against national interest if we fed our current account deficit by privatising our major assets like PSO or selling shares in foreign markets. Soon we will run out of sellable units and face higher current account deficits stemming from mounting remittances of profits of privatised industries.
The liberal import policy needs to be examined in light of the current situation. Luxury items should be banned and tariffs on non-essential finished goods have to be hiked in order to reduce the level of imports.
Given the foreign assistance we are receiving on economic and military side, there is no threat to foreign exchange reserves. FDI in first five months of the current year is over $2 billion. However, we need to adopt a new paradigm for economic growth in which high rate of growth does not lead to high rate of inflation. Containing inflation to a rate below five per cent should be a higher priority than promoting GDP growth. Other wise if our inflation rate remains at eight per cent for another two to three years, our current account deficit cannot be sustained and our exchange rate is bound to cave in.
The author is former Secretary Planning