Macro Bites

Macro Bite # 16

5 min read

Last week, our founder joined Deep Dive Pakistan to talk about Macro Pakistani’s story, explain what the twin deficits are and why he is hopeful about the future of Pakistan’s economy. You can watch the full video here. A bonus from that podcast has been the significant number of new subscribers who have joined the platform since. For all new subscribers, you can read previous newsletters in the Bites section of our website. Thank you for your support so far and reply to this email with any feedback you might have.

Why has trade in Pakistan failed to pick up?

One of the twin deficits discussed in the podcast, was the current account deficit, which includes:

  • Trade balance: exports minus imports of goods and services
  • Primary income balance: repatriated profits or returns on investments
  • Secondary income balance: one-sided transfers such as aid or remittances

Broadly speaking, the current account, along with the smaller capital account, needs to balance with the financial account. The financial account includes Foreign Direct Investment (FDI), portfolio investments in equities or debt and foreign loans. If these sources of funding aren’t enough, the State Bank has to resort to using up its reserves which are kept for rainy days.

We need balance

Historically, Pakistan has been unable to attract enough dollars to finance its current account deficits. Each time the country goes through a balance of payments crisis, it asks ‘friendly’ countries or the IMF for loans. Below is a snapshot of what Pakistan’s balance of payments has looked like in recent years

Source: State Bank of Pakistan

As the current and capital account deficits increased, net borrowing requirements from the rest of the world also increased. The bulk of this borrowing came in the form of foreign loans (as highlighted in red) rather than from FDI or portfolio investments. It was only after devaluation recently, that these borrowing requirements fell.

Devaluation is good

Apart from the structural issues we have already discussed at Macro Pakistani, a primary driver of Pakistan’s current account woes was its overvalued exchange rate.

Source: State Bank of Pakistan

The dotted line (Nominal Exchange Rate) in the chart shows how the currency was fixed at 100 PKR/USD for several years while the green line (Real Effective Exchange Rate) was rising. When countries trade with others, they consider the value of the currency of their trading partner, in relation to the value of other currencies, adjusted for inflation. To understand this and its impact on trade in Pakistan read the full article below.

The main takeaway, however, is that exchange rates are meant to be shock absorbers. By keeping the exchange rate fixed, Pakistan essentially taxed its exporters since their goods and services became less competitive in international markets. Once the currency was devalued and allowed to reach its fair value, in real and effective terms, the current account position improved.

Let’s get real again

When you let the currency devalue, two things happen. First, exports become relatively cheaper and the country’s goods and services become more competitive

with the rest of the world. Next, imports become relatively expensive and other countries’ goods and services become less attractive. As the above chart shows, the current account becomes worse before it becomes better. But as the below chart shows, it does become better.

Source: Pakistan Bureau of Statistics; MP Analysis

In volume or real terms, exports have risen since 2018 while imports have been on a downward trajectory. In 2020, this trend continued. While the growth rate of exports fell sharply due to COVID-19 in the last quarter, imports fell even faster and the current account deficit decreased. In addition to the exchange rate, depressed demand in the economy along with low oil prices also helped reduce imports.

Manufacturing is a problem

While overall exports are on the rise, manufacturing is still lagging behind as other structural issues remain unaddressed. Since 2016, the quantum of overall exports has increased by 32% while manufacturing has only increased by 13%.


Source: Pakistan Bureau of Statistics; MP Analysis

Competitive exchange rates do not automatically translate to competitive goods and services. Pakistan ranks 110th out of 141 countries included by the World Economic Forum in their Global Competitiveness Report 2019. Other regional peers like India (68th), Sri Lanka (84th) and Bangladesh (105th), are all ranked higher.

Pak Cheen Dosti

Pakistan needs to carefully assess its foreign geo-political ties and negotiate market access accordingly. While the US contributes over 20% to Pakistan’s trade surplus, our deficit with China makes up 30% of the total trade deficit, which means we import a lot more from China than we export. In 2006, Pakistan and China signed a Free Trade Agreement (FTA), which gave each country certain preferential treatments. While the agreement was successful in significantly improving bilateral trade between the two countries, according to the Pakistan Business Council, it favored China more than Pakistan. Chinese goods inundated the Pakistani market and contributed to premature industrialization.

Source: OTEXA

However, the recent US-China tensions offer an opportunity for Pakistan to bolster its trade surplus with the US. Since June 2018, political tensions have led to US significantly reducing trade with China. From a high of over 40% share of US textile imports, China was down to less than 15% share before the pandemic. This reduction of 25 ppts in share was absorbed by countries like India (4 ppts), Vietnam (3.2 ppts) and Bangladesh (3.0 ppts). Pakistan has managed to increase its share of US textile imports by only 1.2 ppts, even lower than Cambodia (1.7 ppts).

Read the full article if you want to understand the state of Pakistan’s trade ties with other economies and more. Having completed a broad understanding of Pakistan’s structural economic issues, we will next see how the country has performed compared to its communicated plans.

Read the full article in the link below

Why has trade in Pakistan failed to pick up?

Explore what makes up the balance of payments, what role devaluation has played in boosting trade in Pakistan and how foreign relations can affect growth moving forward.

Read more

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Faiz Ahmed

MBA Candidate at Harvard Business School with prior experience at Bain & Company, International Finance Corporation and State Bank of Pakistan. He is also the Founder of Macro Pakistani.

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