State of the BoP

The SBP has released recently the numbers on the balance of payments for the first quarter of 2018-19. The various key magnitudes reveal mixed trends. The negative developments identified below will require quick and strong corrective actions.

The trade deficit has increased by almost 8 percent. This has happened despite a number of devaluations of the rupee since December 2017. The value of the rupee with respect to the dollar was 18 percent lower in the first quarter of 2018-19 compared to the first quarter of 2017-18.

Despite the significant fall in the value of the rupee, imports have continued to increase by almost 6 percent. This is attributable to the big jump in the oil import bill of over 40 percent, primarily due to the escalation in the price of oil. There has been some impact of the rupee depreciation on non-oil imports which have fallen by 4 percent. This is a relatively small decrease given the large devaluation and demonstrates the relative inflexibility of imports. In fact, much of the fall in non-oil imports is in imports of power generating machinery resulting from the slowdown of CPEC.

Also, exports should have responded more to fall in the rupee by 18 percent. They have grown by only 4 percent. Despite the offering of generous export incentives to textile exports they have increased by only 6 percent. In fact, the export of other manufactures, mostly by SMEs, has actually declined. The only redeeming feature is the big jump in food exports of 29 percent.

Three tentative lessons can be drawn from the short-term trends in the balance of trade. First, exports are beginning to be adversely affected by the ensuing global trade war and competitive devaluations by countries, including China and India.

Second, the limited response of imports to devaluation of the currency and imposition of regulatory duties implies that other instruments will have to be applied to contain imports and restrict the size of the trade deficit. The options are across-the-board introduction of cash margin requirements on imports at varying rates and the fixing of minimum import prices on major imports like iron and steel, chemicals, etc., which may be subject to under-invoicing. This practice has already been adopted by India in the case of 28 imported items.

Third, the process of import substitution by domestic industries appears to be faltering despite the apparent increase in the level of effective protection due to the rise in import prices in rupees. The recent increase in gas and electricity tariffs will partially negate the increased competitiveness and make the economy more vulnerable to higher imports.

The only real silver lining in the current account is the 13 percent increase in home remittances. They had earlier lost their buoyancy after 2015-16. Interestingly, the big increase in inflows has come from the US, the UK and the UAE of 32 percent, 18 percent and 11 percent, respectively. Hopefully, this growth in remittances will continue unabated in subsequent months.

Turning to the financial account of the balance of payments there has been an overall increase during the quarter in the inflow of 20 percent. However, this is largely due to the big receipt of swap funds of $2 billion from China in July 2018. The net inflow otherwise is only $238 million.

There are two developments in the financial account which are especially worrying. First, foreign direct investment has fallen by 37 percent and there has been a significant outflow of funds from the stock market presumably because of the process of decline in the value of the rupee.

Second, the net inflow of foreign assistance to the Government has actually turned negative. Perhaps for the first time, the disbursement of new loan funds has become smaller than the payment of amortization on past borrowing. The country is well and truly in the ‘debt trap’.

The fundamental question is why there has been a 37 percent decline in the disbursement of loans in the first quarter of 2018-19? Is it because lenders are becoming increasingly risk averse to making loans to Pakistan, given its low and declining foreign exchange reserves?

The answer is definitely a yes in the case of multilateral agencies like the World Bank and the Asian Development Bank. Their combined disbursement in the first quarter is only $145 million. This is 39 percent less than the level in the first quarter of last year and only 7 percent of the annual budget estimate. Clearly, these agencies will need a letter of comfort from the IMF before they can raise their level of lending to approach the targeted disbursement of $2.2 billion in 2018-19.

The other key expectation in the budget estimates is the floatation of bonds of $3 billion in 2018-19. This should have happened at the start of the year when reserves were close to $10 billion and, more or less, adequate to provide import cover of two months. Similarly, the level of commercial borrowing has been only $240 million in the face of a target of $2 billion. Is this also because foreign commercial banks are also getting more concerned about the credit worthiness of Pakistan?

Overall, the total gross inflow of external borrowing by the government in the first quarter is $1 billion. This is 31 percent less than the level in the corresponding quarter of last year and only 11 percent of the annual target of $9.7 billion. Indications are that there may be a short fall of up to $3 to $4 billion in the inflow from traditional sources. This is where thanks are due to the Kingdom of Saudi Arabia for its support package, which could help greatly in making up for the substantially lower inflows from the above-mentioned conventional sources. In this sense, the KSA funding will not be an addition to the budgeted inflows but will only contribute to the realization of the expected disbursements in 2018-19. Of course, any further support from other friendly countries will help in closing the financing gap.

There is need also to highlight one particularly negative development in the month of September 2018. The balance in the financial accounts is also negative. This is extremely unusual and highlights the vulnerability of the balance of payments position. Consequently, foreign exchange reserves have declined by as much as $1476 million in September 2018. Henceforth, there will be need to not only watch developments in the current account but also to monitor and highlight the trend in the financial account of the balance of payments. Hopefully, in subsequent months, the net inflow into the financial account will become positive once again, especially when transfers from friendly countries are received.

In conclusion, the first quarter of 2018-19 has raised some concerns about the state of the balance of payments. There is no room yet for complacency based on the support that is potentially forthcoming from friendly countries. The trade deficit remains sticky at a relatively large level despite a big devaluation of the rupee. The process of reducing the current account deficit must continue even in the presence of large capital inflows for attainment of a sustainable balance of payments.