Trade Deficit – Does it alarm the bells of tension again (Four ways to curb external vulnerability)

The country’s external sector is once again under growing pressure. According to the Pakistan Bureau of Statistics (PBS), the Trade deficit – the gap between imports and exports- in August-2021 reached an all-time high at US$ 4.06 billion- the previous high was US$ 3.77 billion in June-2018.

Increasing imports and uncertain foreign direct investment have put the country on the verge of risk. It has been three years now, the Pakistan Tahreek-e- Insaf (PTI) led government has done incredibly well to control the trade balance. But for the last three months (June to August 2021) the trend seems to be reversed, where two times- in the same period imports went up by US$ 6 billion affecting the trade balance abruptly and put the currency depreciated by almost 10% in the same period due to existing flexible exchange rate regime.

In FY22, the government of Pakistan has estimated around 2 to 3 billion US dollars of current account deficit (CAD), whereas the State Bank’s Governor predicted CAD will remain in the range of 2 to 3 percent of GDP which makes roughly 6 to 9 billion US dollars. We have to accept the fact that growing economy and rising import is good for the economy especially in the present COVIID-19 era. On the contrary, it raises some serious questions about sustainability. The time has arrived where we need to make an obvious trade policy before things get worse because if we don’t do it now, after a couple of years we will face the music by knocking on the doors of IMF for bailout over and over again. We must not forget that in December 2019 IMF approved 39 months, 6 billion US$ Extended Fund Facility for Pakistan, which is yet to be completed. The rising trade balance could mean more pressure from the IMF, which would definitely affect the inflation and growth of the economy.

Export, export, and export… this is what the current government’s trade policy manifesto is. Three years have gone by, but the vulnerability of the external sector is still hanging on the doors, despite export has increased remarkably by 18% in the outgoing year. Besides export, the government has to think out of box solution and put the country ahead before we trap again in a vicious circle of external deficit. Since the trade deficit is all about production and consumption, the policies that will be the most effective in reducing the balance are those which affect the less spending of government, citizens, and businesses. Following are some structural reform strategies that would help the government for timely arrangement before it does alarm the bells of tension again.

1) Import Substitution
It refers to the trade and economic policy replacing foreign goods with local production of industrial goods. Import substitution can be a good strategy for any developing country especially for Pakistan which relies heavily on imports to meet day to day needs of countrymen. For instance, if a country’s export rise by 10% in a year that will increase overall by US$ 2.5 billion (considering the fact that total export for the outgoing year was US$ 25 billion approx). Likewise, if we produce goods locally and it reduces the import bill by 10% in a year that can save by US$ 5.5 billion (considering the fact that total import for the outgoing year was US$ 55 billion approx). Hence the net effect that will save the dollar outflow would be US$ 3 billion ($5.5 billion – $2.5 billion). In this way, import substitution can change the whole equation. In addition to it, we will have better quality, more employment opportunities, technology transfer, lower corporate tax burden, or improve the country’s infrastructure. Such arrangements take some time but are worth paying off.

2) Import Taxes and Quotas
Another strategy from the government that will have an immediate impact is simply to introduce some quotas of the products by putting a cap on some products that can be imported from abroad. No matter what the locally manufactured quality of the product is, it will reduce the number of goods from abroad which in turn decreases the outflow of foreign currency. However, one must keep in mind that charging higher duties does not mean to discourage the imported goods but rather it makes the imported goods expensive may reduce some consumption. Such policy measures may also retaliate because foreign nations might take similar steps to discourage our export.

3) Demand Reducing Policies
Our country often runs a trade deficit, not because of trade deals, but because our citizens spend more due to the informal economy and having more money supply in the economy. More money in their hands means citizens have more room for exorbitant spending, such as countrymen easily buy luxury and expensive products that can only be sourced abroad. The best way to curb the demand for imported goods is to adopt monetary and fiscal policies. A tight monetary policy could help to reduce the money supply in the economy which in turn reduces the demand for goods and helps in reducing the balance of payment crises. Our country is already experiencing high inflation, a tight monetary policy help to curb the rise in prices and reduce the aggregate demand. In this way, lower inflation will reduce the tendency for imports, both on the part of consumers and businesses. We must not forget that a tight monetary policy could adversely affect the investment and growth rate of the country. Therefore, in a developing country like Pakistan strategists must use monetary policy along with other appropriate trade and fiscal policies to overcome the problems of rising balance of payments crises.

4) Increase the prices of Petroleum Products and look for alternatives
One of the main reasons that Pakistan runs a trade deficit is because of the huge petroleum products import bill. Roughly 20% of the total import bill is for petroleum products. According to the regional comparison survey conducted recentely, the prices of petrol in Pakistan were stood the lowest. It means the government has some space to reduce the demand by raising the prices. For example, if it were more expensive, the citizens will consume less. Indirect taxes on petroleum products will raise the prices and increase revenue hence help the government in close imbalances. While many worry that the rise in fuel prices triggers inflation and cost of production and makes the export less competitive. But, if the prices are not raised then the currency depreciation will bring the inflation home. So the authority needs to handle it tactically, who to provide benefit and who do not. Another approach government can do is to research and install alternative sources of energy projects where oil and fuel can be substituted by solar, wind, and hydro energy.

Sooner or later, the government has to take some hard decisions. Correction of trade deficit is relying on a judicious combination of policy measures. There is no absolute reliance on any single strategy/ policy measure. If the government is serious about reducing the trade balance, there is room for more than one approach. But the significance of policy depends on the nature of disequilibrium.


The author is an independent researcher/ writer.

Writer:

Shankar Lal
Karachi, Pakistan
shankar.wadhwa87@gmail.com

References:

• Freund.C,. (2017), Three Ways to Reduce a Trade Deficit, Peterson Institute for International Economics (PIIE), (Published online on 03 Dec, 2018).
• Ross.S., (2021), Understanding the Effects of Fiscal Deficits on an Economy, Investopedia (Published Online on 20 May, 2021).
• Boyce.P., (2021), Trade Deficit Definition, Boyce Wire, (Published Online on 25 Aug, 2021).


Shankar Lal

Independent Researcher/ Writer, completed MS from Mohammad Ali Jinnah University, Karachi.

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