08
May

Our Economy's External Sector

Published in Hilal English

Written By: Dr. Farrukh Saleem

How do we keep a pulse on the economy? How does one evaluate the real health of an economy? Broadly speaking, an economy can be divided up into the internal sector and the external sector. Economic indicators are then used to ascertain or judge the current or future health of the economy. Here’s a review of our economy’s external sector based on exports, foreign direct investment, foreign exchange remittances and external debt.

 

ourecoextr.jpgExports: Pakistan’s exports as a percent of our GDP are at a 25-year low. In 1992, our exports stood at 17 percent of our GDP while the same now stand at 7 percent; what a steep fall! In dollar terms, our exports have come down from $25 billion just five years ago to a current figure of around $20 billion; a steep fall of around 20 percent in just five years. Amazingly, Bangladesh’s exports over the same five – year period have grown from $24 billion to $35 billion – a 45 percent jump.

ourecoextr1.jpgIn 1991, Pakistan’s share in world exports stood at 0.18 percent which has since come down to 0.14 percent. In 2004, Pakistan’s trade balance as a percent of our GDP stood at [plus] 1 percent of GDP; the current trade balance is [minus] 7 percent of GDP. As far as the trade balance is concerned, the year 1985 was even worse but the deterioration over the past thirteen years is a serious matter.


Foreign Direct Investment (FDI): In 2007, Pakistan attracted $5.59 billion FDI. The current figure on FDI is around a billion dollars – 80 percent drop in ten years. In 1996, our share in world FDI stood at 0.26 percent which has since come down to a paltry 0.12 percent of world FDI – 55 percent drop.

 

ourecoextr4.jpgImagine; in 1960, we were 1.5 percent of world population and now we are 2.56 percent of world population while our share in world exports is shrinking and our share in world FDI is also on its way down. To be certain, we are missing the boat.


Imagine; five years ago our labor force numbered 61 million which now numbers nearly 70 million but our exports have gone down from $25 billion to $20 billion over the same period. Aren’t we missing the boat?


Remittances: Pakistani workers sending back their hard-earned dollars back to Pakistan have been and continue to be the backbone of our external sector. A year ago, Pakistanis sent back a colossal $20 billion back to Pakistan and that covered around 40 percent of our import bill. Of the $20 billion roughly 65 percent comes from five countries: Saudi Arabia, the UAE, Kuwait, Qatar and Oman.


Foreign workers from all over the world working in Saudi Arabia, the United Arab Emirates, Kuwait, Qatar and Oman have been remitting back a wholesome $100 billion a year to their home countries. No more (courtesy of the oil price crash).


For Pakistan, Saudi Arabia is the source of 30 percent of our workers’ remittances and Saudi Arabia’s budgetary deficit has now ballooned to $100 billion. Saudi Binladin Group, the construction giant, has already laid-off 50,000 of its 200,000 workforce. For Pakistan, remittances from Saudi Arabia, the U.S. and the UK are down 6.2 percent, 6.9 percent and 8.5 percent, respectively.

 

ourecoextr2.jpgExternal Debt: This is the portion of our national debt that has been “borrowed from foreign lenders including commercial banks, governments or international financial institutions. These loans, including interest, must be paid in the currency in which the loan was made.”


Over the past three years, additional loans to the amount of $25 billion from foreign lenders have been taken. Of the $25 billion, an amount of roughly $12 billion went back towards the payment of previous loans. Net foreign borrowing thus amounted to $13 billion (in addition to domestic borrowings of over Rs. 3 trillion).


The economy seems headed into a ‘debt trap’ whereby we must borrow more just to pay back what has been borrowed in the past. In 2016, state-backed Chinese banks rescued us by lending $900 million. In the first three months of 2017, we borrowed an additional $300 million from the Chinese (Pakistan’s trade deficit with China has doubled over the past few years).


Pakistan is now seeking an additional $600 million from the Asian Development Bank (ADB) in the name of Public Sector Enterprises Reforms Tranche-II and III. Pakistan is now seeking an additional loan of $100 million from the French Development Agency (AFD). Pakistan is also seeking an additional loan of $750 million on commercial terms from China for Pakistan to pay back a $750 million, 10-year Eurobond that was floated back in 2007 (and is maturing this year).


In 1971, our total debt (external plus internal) stood at Rs. 30 billion. In a matter of 46 years our public debt has moved from Rs. 30 billion to Rs. 22,000 billion.


In 2008, the per capita debt – debt owed by each man, woman and child in the country – stood at Rs. 40,000. The same has since gone up to Rs. 115,000.


The truth is that our exports have now become uncompetitive in the world market because input costs in Pakistan – electricity and natural gas – are now the highest in the region. Additionally, the cost of doing business in Pakistan is now the highest in the region and our rupee has become grossly overvalued. Our return back to another IMF rescue is inevitable. Pending things for elections is not leadership but expediency.


Lo and behold, we refuse to accept that our external sector is in deep trouble. As a consequence of the refusal, there’s no policy to turn things around; one must first recognize that there’s a problem for problem solving to begin.

 

The writer is an eminent analyst who regularly contributes for national and international print and electronic media.

Twitter: @SaleemFarrukh

 
26
December

Structural Problems of Pakistan's Economy: The Way Forward

Published in Hilal English Jan 2014

Written By: Dr Zafar Mehmood

What are the structural problems of an economy? These are essentially the structural imbalances that act as binding constraints to sustained economic growth and development. In case of Pakistan the structural problems include: disproportionately higher involvement of government in economic activities, large informal economy, agriculture remains a major employer of workforce, concentration on cotton-related production activities, policies biased toward import-substituting activities, neglect of services economy in public policies, low rate of savings and consequently inadequate investment to develop human resources and infrastructure, inability of the government to collect enough tax revenues, neglect of small and medium enterprises, ineffective governance and institutional structures, lack of accountability, etc.

Deep rooted economic reforms are thus needed to remove these structural imbalances to increase efficiency, improve competitiveness, stimulate entrepreneurship, and technological progress. It may be noted that when cyclical macroeconomic measures stop producing results then the only way left with economic managers is introduction of fundamental structural reforms. Pakistan is currently at this crossroad.

Pakistani economy is currently trapped in low growth, high inflation and unemployment, falling investment, excessive fiscal deficits, and a deteriorating external balance position. Foreign exchange reserves are steadily dwindling owing to low foreign capital inflows, heavy debt repayments and slow growth in foreign earnings. Currently, Pakistan has foreign reserves to pay only about a month's import bill. These are the outcomes of failure to timely address the structural problems faced by the economy. Failure to deliver 'inclusive' growth in turn is threatening the social stability of the society.

Savings rate in Pakistan is persistently low as compared with the investment requirements. This is one of the main reasons as to why we have to rely on foreign capital. When foreign capital is not available then the investment rate further goes down, which has adverse implications for growth and employment. Main reasons for low private savings in Pakistan are: low or negative real interest rate, unstable income, large family size, low education level, high inflation, lack of culture to save, etc.

Energy crisis being faced by the country is believed to be mainly due to circular debt, untargeted subsidy, distribution problem, and theft. Government provides large subsidy owing to high generation cost compared to the price charged by distribution companies. Why the cost of electricity is high in Pakistan? We often find arguments explaining that it is high because oil price is high and line losses including the theft, are high. But I think there is more than this, and that can be attributed to inefficiency in power generation due to the use of obsolete technology by power generation companies, their wastage and frequent breakdown of plants, and the outdated transmission system. On the demand side, government does not take measures to curtail demand for electricity. Demand side measures must be introduced in Pakistan. In contrast, what we see in Pakistan, as per report of a major international electric appliance company, that its sales increased by 60% in just one year during 2012. What is the policy response to such an uncontrolled demand? Probably none.

Large informal segment of the economy escapes from national laws and regulations. Due to unrecorded nature of the informal economy, it is not covered in official statistics. As a result, most of the official economic indicators present a dismal position. There is a need to document the informal economy.

Besides huge debt servicing, loss-making State-Owned Enterprises (SOEs) are consuming large sums of budgetary resources, which constitute a drag on the public finances as well as on economic growth. Losses of SOEs are mainly due to corruption, inefficiencies, over staffing, and incompetent staff. Government has been providing resources to SOEs to ensure that these enterprises keep running. However, no effective effort is made by SOEs to improve their productivities, efficiencies, etc., to make themselves viable on sustainable basis. Consequently, each year a huge sum is used by the government for the survival of SOEs.

The ill planned tax reforms have failed to deliver the desired results. Tax reforms are introduced in an ad hoc manner, which lack commitment to take hard decision. Frequent introduction of withholding tax itself speaks of lack of government's competence or will to directly collect the taxes. It is hard to imagine why exemptions to certain activities are given in the tax system without any public debate. Why most of the services sector and businesses remain outside the tax net? Why the agricultural income tax is not collected by the Centre like income tax on other sectors? Why the formal sector industries do not fully pay the sales taxes they collect on behalf of the government from consumers? Why amnesty schemes are introduced by every other government with a clear understanding that tax avoiders and evaders will again indulge into such practices? Is this the acceptance of our failure? Answers and solutions to these questions can substantially increase the tax base.

Many of the problems being faced by the economy are due to weak regulatory system. In turn, the lax enforcement of laws and regulations is due to weak institutional capacity. This can be seen especially when it comes to the application of tax laws and competition law. In case of taxes, people evade and avoid taxes with connivance of tax officials and loopholes in the system. Inapplicability of competition law facilitates sellers in general, to not only cheat on price, but on quality as well.

Given its deep rooted structural problems, Pakistan needs to introduce economic reforms. It should introduce strategically planned reforms without haste. While introducing reforms, the government must keep in front social implications of reforms such as unemployment, environmental degradation, and economic dislocation. Reforms should also be designed in such a manner that they do not create any disparity between the provinces. All of this requires a strong political will and consensus between federal and provincial governments.

Introduce structural reforms in the areas of trade, SOEs, and business climate, which in turn will encourage higher investment. Restructuring and privatization of SOEs should aim to ultimately help restore fiscal stability as well as boosting investor confidence in Pakistan's future economic prospects and opportunities, leading to higher growth and job creation. In the area of trade, remove bias in policies against exports, remove commodity concentration, diversify export markets and improve international competitiveness of exports. This will enlarge our export share in global and regional markets.

Business environment should be made friendlier by simplifying start-up procedures, internationalization of companies, education of entrepreneurs, reducing administrative burden, and introducing reward of excellence for promoting entrepreneurship.

Urgent policy actions are needed to place Pakistan on a higher and inclusive growth path including: (i) strengthen public finances through revenue mobilization, cuts in wasteful and low-priority expenditure, and a strengthened fiscal decentralization framework; (ii) reform the energy sector to remove power deficit and untargeted subsidies, (iii) reduce government's involvement in the economy; (iv) implement financial policies to reduce inflation, protect the external position, and safeguard the stability of the financial sector; (v) remove imperfections in the market by strengthening competition law and its enforcement; (vi) remove unnecessary controls so as resources are reallocated in desired direction; and (vii) remove policy bias against the private sector, non-agriculture sectors, and non-textile sectors. An important structural change would be to make the economy less dependent on foreign assistance for sustaining growth. This may take time, but the process must begin now. In this regard, measures should be introduced to induce more savings by all agents of the economy.

Private sector is the engine of economic growth in any economy. Unfortunately, most of the economic policies, especially financial, are biased against the private sector. Consequently, this sector has failed to make desired contributions in the economy. The private sector should be allowed to play the leading role in all economic activities; of course, within a well-functioning regulatory environment. The govern-ment's primary role should be limited to provide social and physical infrastructures, and social protection to poor.

The writer is an HEC Foreign Professor and presently on the faculty of NUST Business School, Islamabad. This email address is being protected from spambots. You need JavaScript enabled to view it.
17
December

THE BALI PACKAGE

Published in Hilal English Feb 2014

Written By: Dr Zafar Mehmood

After many ups and downs during the intensive consultations between developed and developing countries, the 9th Ministerial Conference of the World Trade Organization (WTO) concluded successfully in Bali, Indonesia on December 7, 2013. WTO Members have adopted a number of ministerial decisions on several important issues of the Doha Round, including agriculture allowing developing countries more options for food security, development/ Less Developed Country (LDC) issues to boost trade and Trade Facilitation designed to streamline the activity.

This is the first major agreement that has been reached by the WTO Members ever since it was established in 1995. Other agreements struck since then are on financial services and telecommunications, and among a subset of WTO members, and an agreement on free trade in information technology products.The Bali Package comes on the back of the Doha Development Agenda (DDA), which was launched in 2001. The Bali Package is a small but a significant component of the DDA setting out a path for a successful conclusion of the DDA at some future date.

The most significant for international trade is the Trade Facilitation part of the Bali Package, which is about speeding up customs procedures; making trade easier, faster and cheaper; providing clarity, efficiency and transparency; reducing bureaucracy and corruption, and using technological advances. It also has provisions on goods in transit, an issue particularly of interest to landlocked countries seeking to trade through ports in neighbouring countries. Part of the deal involves assistance for developing countries and the least developed countries to update their trade infrastructure, train customs officials, or for any other cost associated with implementing the agreement.

The benefits to the world economy from the Bali Package are calculated to be between $ 400 billion and $1 trillion by reducing costs of trade by 10 to 15 %, increasing trade flows, creating a stable business environment and attracting foreign investment. Pakistan will also benefit from this pie if it takes timely actions. The agreement's positive spin-off will be in terms of growth, creation of more jobs and enhancement of revenue for governments. Much of the rest of the Bali Package focuses on various issues related to development, including food security in developing countries and cotton and a number of other provisions for the least developed countries. Agreement on the agriculture, a part of the Bali Package, required sorting out two issues. Much of the focus of negotiations was on shielding public stockholding programmes for food security in developing countries, so that they would not be challenged legally through the WTO Dispute Settlement Mechanism even if a country's agreed limits for trade-distorting domestic support were breached.

Pakistan fully supported agricultural development schemes to enhance food security and develop food stocks but the ones that are based on transparent, predictable and market based policies that do not distort production and international trade. In this context, it may be noted that the proposed solution will be interim, and much of the discussion was about what would happen at the end of the interim period. The outcome of consultations was for the interim solution to exist until a permanent one is agreed, with a work programme set up aiming to produce a permanent solution in four years. The Bali Package asks member countries to open up their agricultural subsidy regime for scrutiny and not use its subsidy regime to distort agricultural trade through exports. The Bali Package allows improving market access for cotton products from the least developed countries, and with development assistance for production enhancement in those countries.

The package also includes a political commitment to reduce export subsidies in agriculture and keep them at low levels, and to reduce obstacles to trade when agricultural products are imported through quotas. Agriculture subsidies and import quotas are widespread in the European Union that hurts exports of agricultural products from countries like Pakistan. Therefore, any development in this context will be in our benefit. The other issue was about “tariff quota administration”; that is, how a specific type of import quota (a “tariff quota” where volumes inside the quota have a lower duty) is to be handled when the quota is persistently under-filled. Members have agreed on a combination of consultation and providing information when quotas are under-filled. This will increase transparency in the use of import quotas.

Under development issues, four documents remained unchanged from their Geneva versions. These include:

• Duty-free, quota-free access for the least developed countries to export to richer countries' markets. Many countries have already implemented this, and the decision says countries that have not done so, for at least 97% of products, “shall seek to” improve the number of products covered.

• Simplified preferential rules of origin for the least developed countries, making it easier for these countries to identify products as their own goods, and qualify for preferential treatment in importing countries.

• A “services waiver”, allowing the least developed countries' preferential access to richer countries' services markets.

• A “monitoring mechanism”, consisting of meetings and other methods for monitoring special treatment given to developing countries.

Finally, the Ministerial Conference adopted five decisions on the WTO's regular work. They are the following:

• In intellectual property, members agreed not to bring “non-violation” cases to the WTO dispute settlement process – “non-violation“ is shorthand for the technical question of whether there can be legal grounds for complaint about loss of an expected right under the WTO's trade related intellectual property agreement, even when the agreement has not been violated.

• A similar extension was agreed in electronic commerce, members agreed not to charge import duties on electronic transmissions. The Work Programme at the WTO also encourages continued discussions on electronic commerce in relation to commercial issues, development and new technology.

• Ministers decided to give special consideration to issues of small economies. Ministers instructed the Committee on Trade and Development to consider proposals on small economies and make recommendations to the General Council of the WTO.

• Ministers reaffirmed their commitment to Aid for Trade, an initiative that assists developing countries, and in particular the least developed countries' trade. They welcomed progress on Aid for Trade since its launch in 2005 and mandated the Director-General of the WTO to continue support of the programme.

• Ministers directed their Geneva delegations to continue examining the link between trade and transfer of technology and make possible recommendations on steps that might be taken to increase flows of technology to developing countries. The mandate was given at the 2001 Doha declaration.

The text adopted in Bali is not final, although the substance will not change. It will be checked and corrected to ensure the language is legally correct, aiming for the General Council to adopt it by 31stJuly 2014. In conclusion, the Bali Package is a successful development for global trade. Had it failed, it would have dire consequences for the multilateral trading system. Had it failed, Pakistan would have been in difficult position as it is not part of any major regional trading bloc.

The writer is an HEC Foreign Professor and presently on the faculty of NUST Business School, Islamabad. This email address is being protected from spambots. You need JavaScript enabled to view it.
17
February

Effects of Plummeting Oil Prices

Written By: Dr. Zafar Mahmood

Like prices of other commodities, the price of crude oil experiences wide price swings in times of shortage or oversupply. Unlike many other commodities, the crude oil price cycle may extend over several years responding to changes in global demand and supply. Global oil prices have fallen sharply over the past seven months, leading to significant revenue shortfalls in many oil exporting nations. On the other hand, consumers in oil importing countries, including Pakistan, are now paying less.

Between 2010 and mid-2014, world oil prices remained fairly stable at around $115 a barrel. Among the reasons attributed to this trend was the higher consumption pattern by major oil importing nations like China and India. Also, the geopolitical tensions in nations like Iraq and Libya too kept the prices high. As oil producing nations could not keep up with the world demand, as a result the prices rose. But since June 2014 prices have more than halved. Brent crude oil has now dipped below $50 a barrel for the first time since May 2009. US crude, which is lighter and sweeter, has also fallen below $50 a barrel.

The reasons for plummeting oil prices are twofold – weak demand in many countries of Asia and Europe due to weak economic growth, coupled with surging US oil production due to shale gas and oil. Shale is a natural gas found in shale formations – a type of rock in the earth's crust. It is being considered as the new source of natural gas as other sources are fast depleting. US is at the forefront of exploring and producing shale gas. It accounted for 39% of its natural gas production in 2012.

Added to this is the fact that the oil cartel OPEC is determined not to cut production as a way to prop up prices. OPEC members are losing large export earnings but do not want to cut their production at this stage. They are increasingly using their accumulated future generations’ fund to bridge the current account and fiscal deficits.

Russia is one of the world's largest oil producers. Its economy heavily depends on energy revenues, with oil and gas accounts for about 70% of export earnings. Russia is expected to lose about $2 billion in revenues for every dollar fall in the oil price. Consequently, its economy is likely to shrink by at least 0.7% in 2015 if oil prices do not recover. Russian Government has predicted that its economy will sink into recession. Despite this, Russia has confirmed it will not cut production to shore up oil prices. This is because with a cut in oil production, Russia expects that its importing countries will increase their production, which means a loss of its niche markets.

Saudi Arabia, the world's largest oil exporter and OPEC's most influential member, could support global oil prices by cutting back its own production, but there is little sign it wants to do this. Two reasons: first, to try to instill some discipline among OPEC members and second to put pressure on USA's promising shale oil and gas industry, as OPEC now recognizes the challenge of US production. Although Saudi Arabia needs oil prices to be around $85 in the longer term to balance its budget, it has large reserve fund of about $700 bn, so it can bear lower prices for some time. Like Russia, OPEC believes that lower prices would force some higher cost producers to shut down their production so that it can pick market share in the longer run. OPEC has also learned from its history. In the 1980s, OPEC cut its production significantly in order to boost prices, but it had little effect, although it badly affected the member countries’ economies. So this time OPEC is cautious and has shown unwillingness to cut its production level.

The growth of oil production in North America, particularly in USA, has been staggering. US oil production levels were at their highest levels in almost 30 years. It has been this growth in US energy production, where gas and oil is extracted from shale formations using hydraulic fracturing that has been one of the main drivers of lower oil prices. Despite many US shale oil companies have far higher costs, $60 to $70, than conventional rivals; many of them need to carry on pumping to generate sufficient revenues to pay off debts and other costs. With Europe's weakening economies currently characterized by low inflation and weak growth, any benefits of lower oil prices would be welcomed by stressed governments. China, which is set to become the largest net importer of oil, should gain from falling prices. However, lower oil prices won't fully offset the far wider effects of a slowing economy.

Japan imports nearly all of the oil it uses. But lower prices are a mixed blessing as high energy prices had helped to push inflation higher, which has been a key part of Japanese government’s growth strategy to combat deflation. A 10% fall in oil prices should lead to a 0.1% increase in economic output, some experts predict. In general, consumers benefit through lower energy prices, but eventually, low oil prices do erode the conditions that brought them about. Pakistan’s imports of petroleum and its products account for about 33 percent of its total imports. Falling oil prices are expected to ease its current account deficit, which will strengthen Pak Rupee. With low oil price, industrial production cost will go down hence our exports may become internationally competitive. At the same time, revenue from petroleum-related levies will fall because Pakistan imposes ad valorem taxes instead of specific duties. To recover falling tax revenue, government has announced to impose additional 5% sales tax on petroleum products. Lower oil prices are helping government to contain inflation rate. Current inflation rate is 4.3% (December 2014), which is likely to further go down; both consumers and government are cheering. Pakistan’s projected recoverable shale gas is estimated at 105 trillion cubic feet of recoverable gas and 9.1 billion barrels of shale oil reserves. However, its production costs in Pakistan will be considerably high due to the advanced technological requirements and relatively unknown terrain. Pakistan needs a policy to attract technology for its exploration.

The steep fall in crude prices is de facto, a fiscal stimulus. It is likely to boost growth and employment. Consequently, unemployment and poverty will fall. However, fall in earnings of oil exporting countries, especially in the Arabian Gulf region, is likely to reduce inflow of FDI to Pakistan. Default in loans given to shale gas developers in USA could affect the global banking industry which in turn could cause imbalances, and hence a fall in capital inflow from these sources to Pakistan.

All in all, the biggest fall in oil prices since the 2008 global recession is shifting wealth and power from oil producing states to oil importing states. Surging U.S. and other Organization for Economic Cooperation and Development (OECD) shale supply, weakening Asian and European demand and a stronger dollar has pushed oil to a five-and-half-year low, with a price below $40 a barrel not out of sight.

Even as cheaper fuel stimulates the global economy, it could aggravate political tension by squeezing government revenue and social benefits. Pakistan government is quick enough to announce 5 percent additional sales tax on petroleum to account for the falling revenue on this account. Political tensions in some of the oil exporting countries may increase if the fall in oil prices persists.

Pakistan needs to carefully manage falling oil imports bill. With lower oil prices if demand goes up proportionately then import bill will not go down. Pakistan’s domestic crude oil production may fall if marginal producers become uncompetitive. Thus, government needs to make all efforts not only to stabilize the currency but properly manage demand and domestic production, too.

The writer is a Professor of Economics at School of Social Sciences and Humanities at NUST, Islamabad. This email address is being protected from spambots. You need JavaScript enabled to view it.

Follow Us On Twitter