InternationalVOLUME 15 ISSUE # 10

ADB’s new warning on BOP constraints to growth

The Asian Development Bank (ADP) has issued a new warning about the imbalances developing in the Pakistan economy and threatening its growth prospects.

In its latest research paper titled “Why Pakistan’s economic growth continues to be balance of payments constrained”, the ADB has said that the balance of payments crisis is imminent in Pakistan, if its economy grows more than 3.8% annually without fixing existing structural economic imbalances. After analysing various underlying factors, the bank has recommended that in order to avoid the next balance of payments crisis, Pakistan will have to fix its exports and reduce dependency on imports. According to the ADB, in the current structural and product specialisation circumstances, if Pakistan’s economy is to grow faster than 3.8% in the medium-term, external imbalances will occur and distort the entire growth process.

The ADB research paper notes a long-term structural BOP-constrained GDP growth rate of 3.77% for the period 1980-2017. At 4.89%, the average GDP growth rate for the period is higher than the BOP equilibrium GDP growth rate. Periods of GDP growth rates that are higher than the BOP-constrained growth rate tend to result in foreign exchange reserve depletion, followed by periods of fiscal and monetary policy-led suppressed growth.

It is relevant to add here that after witnessing the 2013-18 period of high economic growth, Pakistan again faced the balance of payments crisis, which forced the incumbent PTI government to sign a tough International Monetary Fund (IMF) deal that has retarded economic growth and is now causing increase in poverty and unemployment as well as high prices.

The ADB has pinpointed that the stagnating value of exports since 2012 and slowing remittance growth since 2014 are likely to further push the BOP equilibrium growth rate downwards from 3.8%. In the past as well, macroeconomic measures to reverse foreign reserve outflows often resulted in slowing economic growth.

Significantly, last year, Pakistan recorded a low economic growth rate of 3.3%, which the finance ministry has expected to further slowdown to 2.4% in this fiscal year. However, any growth rate that is below 5% to 6% increases unemployment in Pakistan. The ADB paper has underlined the fact that since end-2017, the government has implemented a number of economic reforms to address the BOP crisis, including regulatory measures, reduced imports, increased interest rates, and depreciation of the exchange rate to the US dollar by almost 33%.

But despite significant currency depreciation, merchandise exports have declined by 2.2%, between fiscal year 2017-18 and fiscal year 2018-19. It should be a matter of concern for policy makers that over the last decade, Pakistan has lost global market share by 1.45% per annum, with foreign exchange reserves further declining from $9.8 billion at the end of FY2018 to $7.3 billion at the end of FY2019, only enough to finance about 1.4 months of imports.

In the circumstances, improving Pakistan’s export performance remains the most relevant long-term structural challenge to alleviate the balance-of-payments constraint to sustained economic growth. Pakistan’s export performance has been weak for decades. Since 2010, export growth has been largely stagnant, with a growing average trade deficit. Pakistan’s exports continue to lose market shares due to the growing proportion of unsophisticated export goods.

The hard fact is that gaps in Pakistan’s trade balance are structural, which accentuate whenever domestic demand grows too fast. Raising Pakistan’s economic growth rate in a way that remains consistent with BOP equilibrium would require reforms that would help its industries produce export products that are more attractive to external markets, as well as reducing the income elasticity of imports. It is important that Pakistan’s import-competing industries should become more competitive, and the energy mix should be altered to become less reliant on oil imports.

Diversification is the key to long-term growth. Pakistan’s industry needs to diversify to help reduce the economy’s dependence on imports. A more diversified economy results in more diverse exports, and this is required to acquire the wider set of productive capabilities that is needed to export goods with a higher level of sophistication. The first steps toward export diversification would be to identify the causes of lost export value in important industries and explore options for moving into new export products that require productive capabilities similar to those used for existing Pakistani exports but have a higher level of sophistication within the product space.

At the same time, there is a need to generate an environment conducive for exports (terms of trade, export insurance, export promotion, and trade agreements). The ADB has also recommended improving the availability of trade finance. To implement the steps, it is required that policy design, coordination, and implementation facilitate private sector attempts to acquire capabilities in latent and more sophisticated products, as well as encourage meaningful strategies to develop new capabilities and products. The composition of imports specially contributes to the BOP constraint. Around 40% of electricity production in Pakistan is oil-based, and 25% is gas-based. Direct and indirect subsidies for the energy sector are incentivising oil consumption, thus driving imports. This needs to be curbed.