The Current Account Deficit in Perspective

Author Name: Usman W. Chohan      02 Dec 2019     Domestic Economy

For the past 40 years, Pakistan has by and large run a current account deficit, which means that the value of goods and services it has imported has exceeded that of goods and services exported. In fact, for the period 1976-2019, according to State Bank of Pakistan (SBP) figures, the country has run a current account deficit of $-480 million on average per quarter.

There was a brief exception to this in the immediate post-9/11 period, when the country ran a slight annualized surplus for the years 2001-2004. However, there were also two periods of drastic deficits, the first being from 2007-2010, reflecting in part the Global Financial Crisis (GFC) and its international aftershocks, and the second being from 2015-2019, with a low point of $-6.3 billion in June, 2018.

Such a long-term import dependency is unhealthy for a developing country, and Pakistan’s current account deficits were being warned about for quite some time. However, when paired with the fiscal deficit, which refers to the gap between the government’s revenue collection and its expenditures, the situation became dire and Pakistan went to the IMF for a bailout in early 2019.

In this backdrop, it was encouraging to see the recent figures released by the SBP, which indicated that Pakistan had, for the first time in four years, run a current account surplus of $99 million in the previous month (Oct 2019). For reference, the Oct 2018 figure was a $-1.2 billion deficit, while the Sep 2019 figure was $-284 million.

This was celebrated by the current government as a sign that the country was moving in the right direction and beginning to shed a long history of import dependence. Yet it is important to understand the drivers behind the current account deficit to identify where improvement is being realized.

The current account deficit is a function of the spread between exports and imports, so it can be addressed by either curbing imports or by boosting exports. Ideally, greater exports result in higher foreign exchange, but require greater public and private effort in an increasingly competitive global marketplace where a country will likely find rival exporters from other countries for nearly every category of goods and services.

So the quicker fix is to curb imports through specific policies including import taxes, duties, tariffs, as well as prohibitive lists. The government in fact drew upon several mechanisms in this case to stem the import bill. In general, curbing discretionary imports, which cater largely to the tastes of the bourgeoisie and can easily be produced domestically (e.g. foreign cheeses, sweets, and other foodstuffs), is often a good place to start.

However, there are certain things which the country must import in order to drive long-term economic growth, and curbing these will in fact put a dent in longer-term prosperity. Three categories of necessary imports include energy products & oil (Pakistan’s largest import category), industrial goods (the 2nd largest category), and base materials (also in the top 5 import categories).

Industrial goods include the machinery that is used in local factories to drive production, and so it is important to continue capital good imports for as long as these aren’t manufactured in the country itself. Energy products (including refined petroleum) are the lifeblood of the modern economy, and not found in sufficient quantities locally, so curbing their imports will hurt both domestic consumption as well as domestic production.

Finally, base materials often tend to be sourced from specific locations around the world through countries that have such natural endowments, and their use in domestic manufacturing makes their import a near-necessity. So curbing imports does improve the headline number of the current account deficit, but it is then important to look at the mix of imports to see how local economic activity is being affected.

Although the SBP projected that the economy might grow by 3% this fiscal year (FY19-20), there are certain indicators which suggest that this pace will be difficult to achieve. Most notably, industrial activity has become frighteningly sluggish, and recorded an almost 6% decline year-on-year during the first quarter of this new fiscal year (July-Sept 2019), according to the Pakistan Bureau of Statistics (PBS). This echoes earlier sluggishness, since large-scale manufacturing output fell by 2.1% year-on-year in the previous fiscal year (FY18-19).

The import cuts may thus be bearing out on manufacturing already, but the problem is compounded by two other factors: higher interest rates that have raised the cost of borrowing, and the rupee devaluation which makes foreign materials extremely expensive. Yet the SBP has maintained the flexible exchange rate and high interest rate under the influence of the IMF’s recommendations, even though these end up working in a contrary manner to the IMF’s stipulated reform objectives.

If industrial and other capital goods are the areas where imports are going to fall in future quarters, then this will also affect both domestic manufacturing as well as exports. This in turn is not a cause for celebration, because an economy can only curb imports by so much before the machinery of the economy itself grinds to a halt.

Furthermore, there is only so much taxation and tariffs on imported goods that can be imposed.  Pakistan has the highest average tariff amongst 70 countries having more than $20 billion worth of annual exports, and the levies of this year have pushed effective tariffs even higher, according to the minutes of a cabinet meeting last week which approved the National Tariff Policy 2019-2024.

At the same time, so much smuggling goes on that it accounts for nearly 60% of the total demand for products of over half a dozen sectors of the formal economy, including petroleum, tea, mobile phones and auto parts industry, for which no import taxes are collected at all, according to the Model Customs Collectorate (MCC) of the Customs Department. Yet tariffs at the import stage constitute around 48% of Pakistan’s total tax revenues, which shows the interplay between the fiscal deficit and the current account deficit, and also the distortionary effect of excise over just a portion of the economy.

Aside from this, there is also the question of the accounting methods used to measure certain key import items. For example, Pakistan’s oil imports from a certain country have been negotiated on a deferred-payment basis, which means that the timing of their delivery and their payment are mismatched such that they can be recorded at the end of the fiscal year (June 2020). From a current account perspective, given that oil is the largest imported item, every quarter might then look good until the very last one of the year when the payment is recorded.

Beyond the current account, it is also important to note that the overall balance of payments of the country have yet to be addressed. A country’s balance of payments depends not just on the spread between exports and imports, but also on the interest payments it must make on external debt that has been incurred in previous years. Pakistan’s overall balance of payments remains negative by $-1.2 billion because of debt servicing requirements.

Yet the markets are beginning to turn optimistic over the headline figure of the current account deficit. For the past month, Pakistan has been the best performing equity market in the world by far, and the rupee has begun to strengthen as well. There is of course a thirst for good news in the economy this year, and economics itself is vulnerable to the “animal spirits” of public sentiments.

But headline figures will only spur continued good sentiment if the common man doesn’t see too large a gap between the headline numbers and his daily lived experience, which requires much more attention than a mere import bill.

The writer is the Director for Economics and National Affairs at the Centre for Aerospace and Security Studies (CASS). He can be reached at cass.thinkers@gmail.com