BALANCE OF PAYMENT CRISIS MANAGEMENT – AN ALTERNATIVE TO THE IMF STRATEGY
Dean CESD, Director Research, Chief Editor PBR, HOD Economics, IOBM.*
Pakistan’s economic managers affiliated with WB – IMF are writing articles with deceptive captions like Doing Away with the IMF. But the write up advocates tried and failed IMF prescriptions of the 1990s. And these articles conclude with the same advise Pakistan has been given since 2008 that Pakistan should go to the IMF if no other options are available. And eventually all other options are closed systematically, and we are told that there is no other option except going to the IMF. These failed technocrats are trying to impose failed prescriptions, that instead of resolving our crises are pitting us deeper into the quagmire. Their total preoccupation is with devaluation, which seems to be the panacea for all our woes. That devaluation has been tried for more than 25 years with no positive results, except for the creditors and those getting their salaries and pensions in foreign currencies. So what these technocrats are advocating is in their own best interest !
In this paper I go on to discuss the Balance of Payment Crisis in Pakistan in section 2. In section 3 the IMF strategy to deal with the crisis and its ramifications on the economy are discussed. In section 4 I have proposed an alternative strategy, which I will show is far superior to the IMF strategy. I first proposed this strategy in a paper in 2000, just refined it further in this paper. I will show that the strategy proposed by me is superior to the IMF strategy in terms of its effects on growth, inflation, debt burden, distribution of income and poverty.
I would like to thank Mr Irfan Lal, Assistant Professor Economics department, CESD, IOBM for help with data collection.
There has been a sharp rise in the deficit on the current account from $4.9 billion in 2016 to $ 12.4 billion in 2017 (Table 1) which works out to be -4.1% of the GDP. This is attributable to a sharp rise in the trade deficit which increased from $ 19.3 billion in 2016 to $ 26.6 billion in 2017.
|Table 1: Balance of Payments Billion US $s|
|i. Current Account (A+B+C+D)||-4.9||-12.4|
|A. Trade Balance||-19.3||-26.6|
|B. Service Net||-3.4||-4.3|
|Of which CSF||0.9||0.6|
|C. Balance on primary income2||-5.3||-5.0|
|D. Balance on secondary income2||23.2||23.5|
|Of which remittances||19.9||19.4|
|ii. Capital Account||0.3||0.3|
|1.Balance from current and capital accounts (i+ii)3||-4.6||-12.1|
|2.Financial Accounts4 of which:||-6.8||-10.0|
|Net acquisition of Financial Assets||0.1||1.3|
|Net Insurance of Financial Liabilities||5.0||8.8|
|3. Errors and Omissions||0.5||0.2|
|Overall Balance (-1+2-3)||-2.7||1.9|
|SBP Reserves (excl. CRR, SCRR)||18.2||16.2|
|Source: State Bank of Pakistan|
The increase in the trade deficit was due to declines in major exports (Table 2). Food and textile items add up to almost 75 % of our total exports and most exports in these two categories like fruits, vegetables, meat, cotton yarn, cotton cloth experienced declines in 20171.The decline in cotton yarn and cloth may be attributed to decline in raw cotton in the previous year by one quarter of total output due to switching to GM seeds. The expectation was that these will be prone to bollworms, was not the case. Other exports experiencing major declines in 2017 include all categories of food items except fish and fish preparations and spices, carpets and rugs, crude petroleum, cement, sports goods, surgical instruments, leather and leather products. This coupled with increase in import of different categories of machinery for CPEC, petroleum, food items and consumer durables inflated the import bill. Notice also the decline in remittances, portfolio investments and Coalition Support Funds (CSF), which also contributed to widen the deficit in the current account. Of these only the decline in the inflow of remittances is worrying. Portfolio investment is more like a ‘fair weather bird’ and is of short term duration, and can not therefore be used for financing long term needs. CSF is at the discretion of the US and cannot be relied upon. These balance of payments imbalances resulted in depletion of foreign exchange reserves from US$18.2 bn to US$16.2 bn in 2017 compared with the previous year.2
|Table 2: Structure of Exports||($ million)|
|Particulars||July-March Values in Dollars||% Change in Values|
|Fish & Fish Preparation||240||276.3||15.1|
|Meat & Meat Preparation||212.4||163.2||-23.1|
|Other Food items||513.8||510||-0.7|
|Other Textile Manufactures||755.2||660.5||-12.5|
|Petroleum Top Naphtha||1.1||32.5||2,955.9|
|Carpets, Rugs & Mats||74||61.2||-17.3|
|Surgical Goods. & Med. Inst||262.7||250.6||-4.6|
|Chemical & Pharma. Pro.||588.5||621.5||5.6|
|All Other Manufactures||180.4||174||-3.5|
|E.||All Other items||681.7||740.5|
Source : Pakistan Bureau of Statistics (PBS)
The standard IMF policy prescription for countries faced with balance of payment crisis is to devalue the currency which through reduction in export prices is expected to expand the demand for exports. By making imports more expensive the demand for imports is expected to be reduced. This narrative does not take low elasticity of demand and supply of our exports and imports into cognisance. With low demand and supply elasticities, the expansion in exports and the reduction in imports might not happen, as a result the trade deficit instead of declining, might actually widen.
But matters don’t end here. Devaluation by increasing the price of imports
unleashes inflation, which the IMF tries to curtail through monetary tightening, resulting in decline in investments, output and employment. And this is the “bitter pill” that has to be swallowed by those turning to the IMF. Although the fallout on the economy and the people is horrendous, the lenders and those drawing their salaries and pensions in foreign currencies stand to gain from devaluation.
IMF’s external sector strategy has been used unsuccessfully in Pakistan since the 1990s. While devaluation has not reduced the trade deficit, increase in interest rates to combat inflation has been summarised in my earlier study: “Consequences of pursuing such policies are: One, it tries to bring about a ‘recessionary adjustment’ rather than an ‘expansionary adjustment’. Second, the strategy tries to impose ‘across the board’ demand restraint rather than ‘selective’ and targeted demand restraint. Third, the cost of adjustment is borne entirely by the middle and poor segments of the society. As a result of these policies the rate of growth of the economy has been adversely affected. The decline in the rate of growth of the Gross Domestic Product (GDP) to 1.3 percent in 1996-97 was the worst in the recent economic history of the country. This was on account of dismal growth performance of the agricultural sector at 0.06 percent and the manufacturing sector at 1.19 percent in that year. The growth performance in 1998-99 was again quite pathetic. The decline in growth rates is having a decelerating effect on personal incomes, business profits and government revenues. Moreover, manufacturing value-added as a share of GDP and manufacturing employment as a share of total employment have both declined during the 1990s. This phenomenon referred to as de- industrialization is actually a post- industrial phenomenon. Its premature occurrence in Pakistan along with the closure of 5000 industrial units, downsizing and restructuring of State Owned Enterprises (SOEs), decline in investments, migration of industrial units that have become non-viable due to escalation in their cost of production are rendering millions unemployed. The official figure of two million unemployed is heavily understated, in view of the prevailing economic conditions in the country. The per capita income which was more or less stagnant during the first few years of the 1990s decade declined in 1994, 1997, 1998 and 1999. As a result of decline in the growth rate, employment rate and per capita income poverty increased from 17 percent to 35 percent. The “Durkheimian-Modernization” perspective linking economic structure to crime variables is being substantiated by the increase in larceny, robberies, murders and suicides. These ugly manifestations of an unjust society are reflected in the form of manifold increase in cases of car snatchings, robberies, murders and two to three suicides daily reported in the newspapers. The country seems to be engulfed in a socio-economic- political turmoil.” (Wizarat, 2000)
This paragraph from my earlier paper brings to the fore the havoc unleashed on Pakistan’s economy as a result of IMF conditional-ties. The focus of IMF strategy is on across the board reduction in imports and increase in exports instead of a targeted approach. Moreover, the IMF strategy passes on the cost of adjustment to the common people instead of those that have benefited from foreign borrowings.3 Moreover, the entire focus is on increasing foreign exchange earnings through increasing exports, other sources of foreign exchange inflows have been ignored.
But is there an alternative to the IMF strategy? Can we finance the deficit in the current account without turning to the IMF? In this paper I am making an attempt to provide an alternative to the IMF’s external sector strategy. Here I am drawing heavily on my earlier papers especially Wizarat (2000 and 2001). The proposed strategy is not just an alternative, but a superior alternative, as it tries to close the current account deficit without incurring the tremendous cost entailed in the IMF strategy.
I have tried to formulate an external sector strategy for Pakistan that does not entail the costs and drawbacks of the IMF strategy. My claim that this strategy is superior to the IMF strategy is on account of the following: First, with hindsight we know that devaluations for the last many years have not increased exports nor reduced the demand for imports. And reduction in import demand has been at a very high cost to the economy in the form of deindustrialization. We are also cognisant of the adverse ramifications of devaluation on inflation, investment, output and employment. In view of the above, I am proposing ‘selective’ demand restraint rather than ‘across the board’ demand restraint. Second, I have tried to pass on the cost of adjustment to the segments of the Pakistani population that have been beneficiaries of current policies. Third, the proposed strategy tries to break the trade-off between economic adjustment and economic growth by trying to bring about an ‘expansionary adjustment’ rather than a ‘recessionary adjustment’. Fourth, I am not trying to increase foreign exchange reserves by increasing exports only, but have focused on expanding exports, reducing imports, increasing remittances, foreign investment and financial assets to increase the flow of foreign exchange reserves. Following measures are being proposed in this study:
Short term measures:
Banning the import of luxury and consumer goods.
Medium to Longterm measures:
Short term measures
Selective Demand Management
Selective demand restraint rather than across the board demand restraint reduces the import demand for consumer and luxury goods, creating space for the import of essential capital goods, industrial raw material and machinery required for economic development. The strategy also passes on the cost of adjustment to elites and wealthy classes, instead of the middle and poor classes. The cost borne by the wealthy classes will be marginal as compared with the tremendous socio-economic-political cost entailed in the IMF strategy. The rich will not become poorer if they do not buy exotic fruits, vegetables, wearing apparel, shoes, perfumes, cars and other luxury goods temporarily. What is more, they can continue to consume these items from their previous collections. And as Griffith- Jones and Sunkel (1989) observe: “The restriction of non-essential consumer imports and production would be the contribution of the privileged sectors of debtor countries ——–” According to the provisional 2017 data $3.5 bn worth of consumer durables were imported into the country (Table 3). By banning their imports, fiscal space can be made available for importing essential capital goods, industrial raw material and machinery
required for CPEC and other developmental needs.
|Table 3: Structure of Imports||($ million)|
|Particulars||July-March||% Change in Value|
|Values in Dollars|
|Milk & Milk food||193.3||186||-3.7|
|Edible Oil (Soybeans& Palm)||1,391.8||1,456.9||4.7|
|Other food items||1,289.4||1,516.4||17.6|
|Power generating Machines||1,341.1||2,367.0||76.5|
|Const. & Mining Machines||223.7||373.2||66.8|
|Aircrafts, Ships and Boats||474.1||331.2||-30.1|
|Other Machinery items||1,657.1||2,536.5||53.1|
|Road Motor Vehicles||1,407.2||1,811.2||28.7|
|Electric Mach. & Appliances||1,320.2||1,658.9||25.6|
|Silk Yarn (Synth &Arti)||468||486.4||3.9|
|Iron & steel Scrap||776.9||765.9||-1.4|
|Iron & steel||1,441.9||1,531.0||6.2|
|G.||All other items||2,799.5||3,139.2||12.1|
P : Provisional
Source : Pakistan Bureau of Statistics (PBS)
Import of essential goods like petroleum through barter trade can also release the pressure on foreign exchange reserves. Moreover, it can bring about an ‘expansionary adjustment’, rather than a recessionary adjustment entailed in the IMF strategy. An example of an expansionary adjustment would be along the lines of an offer made several years ago by the Islamic Republic of Iran for the supply of oil to Pakistan in return for cement and sugar plants manufactured at the Heavy Mechanical Complex in Pakistan. Such a proposal will not only help to save foreign exchange to the tune of $ 6.7 bn (Table
3) but also revive economic activity in the country. Banning consumer durables and importing petroleum and petroleum products on barter we can save a staggering $ 10.2 bn from the import bill. The Malaysian Government is understood to have made a proposal for the export of palm oil to Pakistan on barter. This will release another $1.5 bn.
The major focus of external sector policy should be on creating an exportable surplus that can be bartered for the import of essential goods. Whether this surplus is in the form of orders for the production of cement and sugar plants, increase in export of technical, scientific and management education etc., it will have an expansionary effect on the economy.
Medium to long term measures
Moreover, demand for petroleum products can be reduced by switching to alternatives sources like wind, solar, nuclear and hyder power. Similarly, demand for edible oil can be reduced through education and inculcating awareness regarding the harmful effects of excessive consumption of fats as is customary in our diets, import substituting edible oils and importing edible oil on barter.
We have to explore export markets for fish, textile yarn, wearing apparel and accessories, sports goods, leather and leather manufacturers and surgical instruments. Alternative markets for these could be Central Asia, the Russian Federation, Middle East, China and Japan. Moreover, Pakistan being an agricultural country has a lot of potential to export food items, fruits and vegetables to the European Union, the Russian Federation and other SCO countries. But the consumers in these countries are health and nutrition conscious and the governments are equally alive to the situation and enacting laws to ensure quality assurance of food products imported in these countries. Pakistan on the contrary, under external pressure has been promoting GM seeds, has not passed Labelling Law to allow discrimination between organic, hybrid and Bt crops. In this scenario even if Pakistan is able to produce a large exportable surplus, our exports will be shunned by the health conscious consumer.4
I first presented the idea of relating debt servicing to looted Pakistani assets transferred abroad in 2000.5 I had proposed that we announce a debt management strategy that allocates a certain percentage of this looted money for debt servicing, ensuring the entire amount is serviced in a short period of time. The pros of the scheme are that it meets the quid quo pro criteria i.e. it puts the burden of debt servicing on people who have benefited from this debt. Moreover, it is the only way to solicit the co-operation of countries where this money is invested i.e. tying our interests with those of the creditor countries. Expanding on my earlier suggestion made in 2000 I am now proposing that we use the proceeds of not only looted corruption money transferred abroad, but all corruption money realised from within the country and abroad. And use the proceeds not only for debt servicing, but for closing the current account deficit and building foreign exchange reserves. A task force comprising of NAB and FIA officials, economists, etc can be constituted to work out the modalities.
During the era of the gold standard central banks maintained a major portion of their reserves in gold and a minor portion in currencies. But after the abandonment of the gold standard, central banks hold major portion of their reserves in currencies, but allocate a certain portion to be maintained in gold. Central banks now resort to trading in gold in a crisis management situation only. India is successfully using gold reserve management to maintain its liquid foreign exchange reserves by buying gold quietly from private suppliers and selling it at an appropriate time to enhance its foreign exchange reserves.6 The gold reserve management strategy can be used to strengthen the liquid foreign exchange reserves when required through a buy back agreement in dollars.
If Pakistan wants to avert free fall in the export of food, cotton and cotton manufactures, it will have to ensure quality assurance of its products. It will have to adopt Cartagena Protocols on risk assessment and biodiversity and pass the Labelling Law so that we can categorise our exports into organic, hybrid and Bt. We have to decide whether we want to keep obliging seed companies by increasing the demand for their GM seeds, which they can’t sell in western countries (due to health conscious customers) at the cost of losing our export markets and ending up with a serious crisis in our current account and balance of payments.
In this article I have formulated an external sector strategy that is a better alternative to the IMF strategy on account of the following: One, the current account deficit is adjusted without bringing about a recession. On the contrary, adjustment and economic expansion are brought about simultaneously. So we can save the patient from the proverbial “bitter pill” associated with IMF borrowings. Second, the cost of adjustment which is quite marginal is passed on to the wealthy classes. The wealthy classes bear a nominal cost in the short run only. Heavens will not fall if the rich and affluent classes don’t purchase latest cars, consumer durables, clothing, designer bags and shoes while the country storms its crises.
The short term measure proposed in this study is Selective Demand Management, which includes banning the import of luxury and consumer goods. Moreover, essential imports can be obtained on barter. These will save a staggering $ 11.7 bn from the import bill, resulting in a massive reduction in the current account deficit. The medium to longterm measures include exploring substitutes for essential imports, exploring alternative commodities and markets for exports, repatriation of looted Pakistani assets, Gold Reserve Management Strategy, implementation of Cartegna Protocol on risk assessment and biodiversity and phytosanitary standards and charging market based rates for the use of our infrastructure and services. I have also recommended that agreements signed between the Government of Pakistan and foreign governments should be ratified by other state institutions to prevent rent seeking and corruption.
The balance of payment strategy formulated in this paper is a superior strategy to the one formulated for Pakistan by the IMF since it does not entail the tremendous cost discussed earlier in the paper. Inspite of that, if an inferior strategy continues to be used in Pakistan, then there might be political or hidden agendas. We continue to blindly follow the IMF not because alternatives are not available, but because of a lack of political will to get the country out of the quagmire in which it finds itself !
Griffith-Jones, Stephany, and Sunkel, Osvlado (1989), Debt and Development Crisis in Latin America:The End of an Illusion, Oxford : Oxford University Press Pakistan Bureau of Statistics, internet.
State Bank of Pakistan, Balance of Payment Manual 6. Wizarat, Shahida, (2001), Bypassing the IMF, Dawn, 12 April Wizarat, Shahida, (2008), Why IMF is not an option’, Daily Dawn, 26 August. World Bank, (2017), Pakistan Development Update, November.