Growing deficits & ‘healthy imports’

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IF you missed it this week, it’s alright. The problem is here to stay, and you will have plenty of chances to catch it in the next round. The news itself sounds dry: Pakistan’s current account deficit for the month of July crossed $2 billion.

By itself it may not sound like much, until you start taking in the context. For instance, last year the figure was $662 million for the same month, so this is just about a tripling of the deficit. The overwhelming amount of this increase comes from import of goods (as opposed to services), which jumped by $1.58bn, up by more than 50 per cent from last year. This is a huge spike.

Next, for some more context, consider where this figure was supposed to be. We do not have the monthly projections for the current account deficit. The government only makes annual projections that are then shared with the IMF which releases them in its various reviews. Consider what those figures were in the last two reviews.

In October, the Fund released its last review of Pakistan’s economy under the Fund supported programme that was completed in that year. In that report, the current account deficit was projected to reach $4.7bn by the end of the fiscal year. In reality, it came in at $12bn by that time. According to Fund projections in October, the deficit was not meant to touch the $12bn level until well past fiscal year 2020.

The increases are accelerating, and the government’s story is built on an assumption that the imports will pay themselves off.

Then came a new set of projections in July in the Article IV consultation report. The new projections said the current account will plunge $9bn into deficit by the end of fiscal year 2017. It will cross the $12bn level by FY 2020, those projections said. Clearly something big was revealed to those who made up these projections between the months of October and July for them to revise their numbers so massively.

But whatever it was that was revealed to them was still incomplete, because as already mentioned, the real figures for the deficit beat both projections by a hefty margin. Then come the July numbers that are the highest monthly deficit recorded in many years, and if we are to do a back-of-the-envelope projection of our own, by assuming $2bn for every month till the end of the fiscal year, we come up with a total annual current account deficit of $24bn. That is more than double where the figure is currently projected to be at, which is $10bn.

Clearly ground reality is outpacing the ability of our economic managers to make a sound projection. If all is well on the external front, and we should not worry, would the secretary finance be so kind as to share with us the projections for where they see the current account going on a monthly basis for the rest of the fiscal year?

Ever since the current account figures began to turn about two years ago (the deficit had fallen spectacularly from 2013 onwards), the government has tried to feed us a soothing line. This is all due to imports of machinery under CPEC, we’re told. Once this machinery is installed, the trend will bottom out as the machinery imports dwindle and exports climb due to productivity increases.

Repeating this line on Monday, the finance secretary reportedly described the trend as driven by ‘healthy imports’, meaning they were enriching the economy and will pay their dividends in the future. Nobody should be too alarmed. Fair enough.

Except that this explanation is cutting less and less ice. The increases are accelerating, and the government’s story is built on an assumption: that the imports will pay themselves off once the associated machinery begins to whirr.

The problem is that fewer and fewer people are now buying that story, and increasingly those whose job is to keep one eye on the deficit and the other on the reserves are beginning to feel nervous. How far is this spike going to go? How low will reserves fall? And how fast?

The reason these questions are important is because at some point, and it is hard to say when exactly that will happen, speculative pressures can break out in the economy that the government will not be able to control the way it controls the interbank exchange rate. If people in large enough numbers begin to feel that a devaluation of the exchange rate is becoming imminently inevitable, the sentiment alone can lead to a large-scale flight into the dollar as people start converting their rupees into dollars and, in some cases, sending the money abroad for safekeeping due to fears about how the government may respond once the shortages of forex at home begin to bite. This is precisely what happened in 2008, leading ultimately to the crackdown against money changers, of which the arrest of Khanani and Kalia was one episode.

Once that point is reached, the situation can be said to be beyond the control of the government, unless they start putting in place capital controls, which will be a sign of panic and will fuel the dollarisation further. At that point the finance minister will not be able to shout the dollar back down, nor will he be able to sing reserves into existence. At that point it will be about arithmetic, which is cold and impervious to all entreaties.

We are not there yet, obviously. But the accelerating pace of the deficits is taking us there, and nobody can see how this trend will be arrested, let alone reversed anytime soon. Already our reserves are just about sufficient to cover three months of imports, down from more than five months import cover at their peak. Below three months of import cover is a threshold for some donor agencies. Sobriety is needed on the external front, and the sooner it comes the better it will be.




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