There is an IMF standby agreement, but what next?

Solving our balance of payments challenge

Dollar 4.4 billion. Pakistan’s foreign reserves with the SBP at the end of June. Equal to less than four weeks of our import bill. Our balance of payments challenge may be our most difficult economic problem to fix.

For the layman, this is basically the difference between the outflows and the inflows of foreign exchange from the country. It is critical because almost all international payments require foreign currency, mostly US dollars. Outflows include things like import payments, foreign loan repayments, and other capital going out of the country. Inflows include things like proceeds from exports, remittances of overseas Pakistanis, foreign direct investment, and loans taken.

Whenever we have a balance of payments deficit, as we almost always do, the deficit is financed by burning existing foreign exchange reserves. When we embark on spurts of growth, the deficit has been as high as $2 billion a month. So, when reserves deplete to as low as four weeks of import cover, as they have every few years (from immediate memory, 1999-2000; 2007-8; 2013; 2017-18; and now) we get to the brink of default; that is, at risk of not being able to honour due international payments. The consequences of default would make the current economic pain we are going through seem trivial.

Our solution; beg the IMF and our friends for an injection of dollars; simply put, fresh loans. We have done this again, and again, and again. 24 IMF programmes to be exact. Einstein says that insanity is trying the same thing repeatedly and expecting different results. Well, we seem not to agree! Going to the IMF is not the issue; continuing to not execute either the IMF’s reform prescriptions, or to have any better ideas ourselves – is what is shameful. It is almost as if we have reconciled ourselves to a state of economic mediocrity, that we will talk about till death, but do nothing about.

Pakistan has so much more potential than what we’ve achieved, and truth be told, we cannot blame anyone but ourselves for our economic woes. Politicians, bureaucrats, the judiciary, and all others who have ruled this country have either played a direct part in creating this crisis, or at a minimum, resisted reform. The media, barring exceptions, has also played into populist, uninformed narratives, making reform that much more difficult.

The good news: things don’t need to be like this. Pakistan can be economically much more resilient. It can be a powerhouse. But it will take years of sustained work. And it will take an attitude of not shying away from difficult reforms, much of which will not be popular and may be misunderstood. To date, that process has not begun in earnest.

Having spent my time in government primarily at the provincial level, this is an area where there are people much more qualified than I am to comment, but just a few thoughts from my experiences from the ground.

Imports are not the issue they are made out to be

Whenever there is talk of our forex challenge, our import bill gets all the heat. “Let’s use less fuel, it’s all imported.” “Close all the markets at 8 PM to save electricity and forex”. “Ban all luxury items.” With time on hand these days, I looked at our import bill in detail. At $70 billion, it is roughly equal to 20% of GDP. Bangladesh is similar. For India, imports are 26% of GDP (around $600 billion). The world average is 30%, and the EU is at 55%. Even in terms of the absolute value of our imports, we rank 50th globally, lower than where we are placed in GDP (ranked in the 40s).

According to 2021 data, energy imports are around $20 billion, or only around 27% of Pakistan’s import bill. Remember, Pakistan has amongst the lowest per capita consumption of energy globally; we rank 167th globally with 29 vehicles per 1000 people; 164th in electricity consumption per capita – just behind Laos, and just ahead of Cambodia, Zimbabwe, and North Korea. Other large categories of imports; electrical and electronic equipment; machinery; iron and steel; pharmaceuticals; edible oil; vehicle related imports; plastics and organic chemicals; together account for another 46%; no one category accounts for more than 8% or $6 billion. Everything else is minor in value. Contrary to our belief, this is not a market that consumes a lot. We don’t really import that much.

Or at least, suppressing imports is not the silver bullet required to fix our balance of payments challenge. You could argue that whenever we get our economy on track sustainably, imports will grow, they must grow, as a percentage of GDP and in absolute terms. We will consume more fuel, more electricity, and need more machinery and more raw materials. But in parallel, this must happen with greater investment in an economy with the capacity to export more.

Stifling imports doesn’t work. This PDM government has tried it the entire past year. Implications: to completely stifle economic and industrial activity, and lose the export momentum built in 2021-22, after a decade. This is other than the rent seeking opportunities created by choking imports at Karachi port and giving babus the discretion to decide who will be allowed to import into the country and who won’t.

Of course, this is not to say that we should be turning a blind eye to our imports. Controlling the exchange rate, as Ishaq Dar did through 2013-17 and this past year, an import subsidy has been given to everyone, specifically the rich, and demand artificially inflated. A market determined exchange rate would itself regulate demand. We need to look at the structure of our imports also, rather than just the quantum. It is dominated by finished or near finished goods. Or looked at differently, our import basket doesn’t result in the sort of value addition that other countries achieve; nor in exciting the world to invest in Pakistan.

The answer lies elsewhere. Think about it. Why do Bangladesh’s exports total $50 billion today, twice what we export. With an apparel industry are we not better placed to develop? Why is it that Vietnam, decimated by war till the late-1970s, had exports equal to Pakistan of $10 billion in 1996, but today has exports of $340 billion? Why is it that Pakistan, the 5th largest market in the world, attracts foreign direct investment of just over $1 billion per year; 84th globally, below Ethiopia, Congo, Belarus, Gabon, Turkmenistan, Bangladesh, and Cote D’Ivoire.

Cracking these questions holds the key to solving our balance of payments challenge.

The Exports and FDI challenge

Consider three numbers:

• Exports: $28 billion (down $4 billion from PTI’s last year in government)

• Remittances: $27 billion (down $4 billion from PTI’s last year in government)

• FDI: $1.3 billion (down 22% versus PTI’s last year in government)

Now remember Vietnam’s export numbers. $340 billion.

Since we need to finance imports of $70 billion plus debt repayment of over $20 plus billion every year for the next three years, the three numbers above mean that we face a balance of payments crisis like never before. Clearly, if our economy performs to its potential, a market the size of Pakistan should be much more attractive to investors. It should also be able to produce and export more. The problem; our economy has never developed in the way it could have.

Growth in FDI and exports is key to solving Pakistan’s balance of payments challenge in the medium and longer term. The issues and solutions involved in solving both issues are similar; and tied to the state and structure of our economy. The challenges and what needs to be done have been written about, talked about, and discussed extensively. There are manifestos, plans, studies, policies, papers upon papers, all saying good things. Result? Very little change.

Here are a few of the important challenges and actions, and the state of the union on each:

1. Political stability and continuity of policy is key to building private sector and investor confidence, yet this has never happened and remains elusive today.

2. The right tax policy and incentives will encourage FDI and exports. This will also help create a level playing field, encourage competition and innovation. Yet our tax policy and implementation do the exact opposite. By overtaxing the formal economy, we tend to consistently encourage informalization and discourage scale, ambition, and innovation. Investors shy away. Firms do not attain the size and scale necessary to develop the capabilities to compete and export in world markets. Money finds its route to the easiest investments there are – real estate for example.

3. Ease of business efforts and the cutting of cumbersome regulatory processes are critical to create a conducive business environment. While Pakistan moved up significantly in the Ease of Business rankings in the PTI government; we must be honest. There is still a long, long, long way to go. The amount of red tape businesses and investors face remains a huge challenge to solve.

4. Providing a level playing field will encourage competition, drive innovation, develop export capacity, and make investment attraction easier. Yet, with our culture of red tape, privileged access, and rent seeking as a means of getting things done, most sectors don’t develop to scale and are dominated by a few players. All these factors act as barriers to competition, and privileged businesses exist by extracting reasonable profits in a protected local landscape. This, as much as anything else, stifles the ambition in these firms required to grow, and to export.

5. Anchor investors from the corporate sector, facilitated by the government, can help to transform sectors, develop value addition capacity, improve product quality, and develop export potential. Yet the corporate sector is viewed with suspicion, over-taxed, over-regulated, and this last year, not even allowed to repatriate profits. Why would they invest in Pakistan?

6. Quality infrastructure such as roads and reliable energy are basic building blocks required to make Pakistan a more competitive business destination. Yet, today, infrastructure remains such that we cannot even guarantee 24-7 energy availability, to businesses or to homes.

7. Special Economic Zones can be used as islands of excellence where investors can be given one stop shop services; yet there is not a single special economic zone anywhere in Pakistan that we have got right and can show as an example to replicate.

8. Access to finance is a critical issue, and while we have talked about this as an issue for ages, we have developed no viable solutions.

9. Our Boards of Investment can work as dynamic organizations that facilitate investors, resolve issues, cut through red tape, and help build a vibrant “Brand Pakistan”. Yet, like every other public sector entity, each of our boards of investment have been bureaucratized.

10. A robust legal framework can give investors the confidence and protection they need with their money. Yet, whether it is our courts, or government after government, we have a track record of scaring investors away from investing in the country.

This is not an exhaustive list. There are other challenges; the impact of the exchange rate manipulation on businesses; the importance of labor productivity, and the poor state of our universities and technical and vocational training; to name a few. The longer we have not solved these problems, the more complex they have become to solve. They are not solvable in a day.

But what should be clear is that in increasing exports and attracting FDI, there can be no shortcuts. We need businesses in the country and outside to develop confidence in Pakistan as a market. This needs to be based on some fundamentals of performance; consistent growth; good profits; and a favourable business environment. None of this can happen overnight. Building confidence is a function of time. What we can do though is to begin now, and with elections just around the corner, it can be the starting point for economic stability. This should be our India 1991 moment.

One fundamental question is to decide whether we believe the solutions to our problems lie in truly committing to an open market economy. I believe they do, and that fundamentally, the 250 million strong Pakistan market with its cheap, young labor should be attractive to the world. But we must stop fooling ourselves that the environment we live in today is welcoming to the private sector. It is not. Recognizing that reality is the first step to solving our problems. And given the state of the economy, there can be no bigger burning platform than now.