After more than
two years, Pakistan began running current account surpluses on the back of
import restrictions earlier this year. The PDM government used this fact as a
testament of their policies. But is a current account surplus that desirable?
Or rather is a current account deficit that bad?
First, let’s get
some basics out of the way. There is a famous accounting identity which is
always thrown around when discussing the current account. That is: a nation’s current
account must be balanced out by its capital account.
Historically,
Pakistan has ran a current account deficit and so, as a matter of sheer
accounting, Pakistan has also run a capital account surplus. Why? Because a
current account balance – among many things – is the savings of a nation’s net
of its investments. So, if Pakistan runs a current account deficit, it means
that it is borrowing savings from abroad (foreigners).
Recently, many
Pakistani ‘economists’ have said that Pakistan is putting the country up for
sale. These statements arose from Abu Dhabi Ports takeover of Karachi
port terminals. But because Pakistan consistently runs a current account deficit
and is unable to attract international debt flows or foreign direct investment
(FDI), putting the country ‘for sale’ is a natural consequence.
Now, borrowing
savings from foreigners isn’t bad in of itself. However, Pakistan borrows
savings to fund its large and persistent fiscal deficit. This is called the ‘twin
deficits phenomenon’.
So, to understand the
nature of Pakistan’s current account deficit, one has to study its fiscal spending/deficit.
And Pakistan’s fiscal spending is largely wasteful
and excessive with little investment in productive capacity or
productivity-enhancing avenues.
Borrowing from
foreigners only makes sense if it’s sustainable and it enhances a nation’s future
income so that they can repay the foreigners in the future. In Pakistan’s case,
the borrowing from foreigners is in the highly volatile form of debt flows.
This is dangerous as when confidence tanks, so do these debt inflows.
At the same time,
the capital account surplus has to be channeled towards projects which enhance
the nation’s future income. This way, the nation’s GDP growth should outrun
debt servicing costs allowing the nation to repay the foreigners in the future.
This does not take place in Pakistan. To understand why, the current account
has to be thought of in another way.
Another way of thinking
about current account is net exports sum net income flows and net current
transfers. To simplify this, think of it as current account = exports – imports
– net profit repatriation + net remittances. These are generally the main
components of a current account especially in the case of Pakistan.
Among all this,
net profit repatriation is not something that can be controlled as it depends
on the business performance of FDI. Similarly, net remittances are not something
that can be directly influenced as they rely on the willingness/need of people
to repatriate their salaries which were earned abroad.
So, the only component
in the current account which can be guided by policymakers is the net exports. And
it also happens to be the largest component of Pakistan’s current account.
In FY22, Pakistan’s
net exports were minus $48 bn. Exports stood at $31.8 bn while imports stood at
$80.1 bn. Many analysts and commentators have repeatedly stated that Pakistan
needs to focus on exporting more and rightfully so. However, this ignores the
composition of our imports.
Economic textbooks
say that it is natural for a developing economy to run a current account
deficit. The process of industrializing requires not only importing machinery
but also ideas and technology via FDI which creates a capital account surplus. Or
put it this way: the high returns to be made from impending industrialization
in developing countries attract investment from abroad.
In Pakistan’s
case, FDI hovers around $2 bn per year while machinery imports only make up 13%
of all imports. Most of Pakistan’s imports are consumption-based such as mineral
products (fuel, oil etc). This is a result of decades-long policymaking
initiatives which have made Pakistan’s energy production highly dependent on
imports. And that is why Pakistan’s current account deficit – as it stands – is
not good.
If one looks
across the border at Pakistan’s neighbors, they’d see that the neighbors too
run large current account deficits. However, their current account deficits are
not consumption-led but rather investment or export-led. For instance,
electrical equipment and machinery makes up 17% of India’s total imports. And
although mineral products make up 38% of India’s imports, much of those mineral
products are imported to be refined for exports (not absorption).
Therein lies the
problem for Pakistan. Pakistan’s imports are largely for fueling domestic
demand. That is what needs to change. Pakistan has to throw out its consumption-based
growth model and adapt both, an investment-channeling and export-based growth
model. It might run a current account deficit in the process, but it won’t be a
current account deficit to worry about.
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