There has been a state of euphoria about the external balance of payments of the country till recently. This has been the result of exclusive focus only on transactions in the current account and no analysis of trends in the financial account. From June to November 2020, the current account showed a surplus for the first time in six years. This was rightly considered as a great success in stabilizing the economy and reducing the pressure on the foreign exchange reserves.
However, things have changed since November. The month of December saw the return of the current account into a deficit which has persisted in January. Nevertheless, over the seven-month period, July 2020 to January 2021, the cumulative current account is still in a surplus of $912 million.
There has been no focus on the big set of external inflows and outflows in the other major account of the balance of payments, the financial account. These flows relate to foreign direct investment, equity flows, change in liabilities of the SBP and the commercial banks, inflows of borrowing into the Government account, outflows of amortization and other transactions.
The financial account of the balance of payments has been in surplus since July 2020. However, up to December 2020 the surplus was only $27 million. In January there is a deficit of $338 million in this account. Currently, the cumulative position up to January is a deficit of $311 million. This is in comparison to a big surplus of $7307 million in the corresponding period of 2019-20.
Consequently, we see a very unusual situation with the balance of payments in January 2021. Both the current and the financial accounts are now in deficit. This has happened for the first time after the second quarter of 2014-15. Clearly, there has been a significant deterioration in the state of external balance of payments of Pakistan.
The fundamental question is what factors have contributed to a worsening of the balance of payments? We look first at the trends in the current account. The balance of trade deficit stands at $13742 million at the end of January2021, as compared to $11598 million in January 2020. As such, the trade deficit has deteriorated in 2020-21 already by 19 percent. In the month of January, the deficit increased even more by 26 percent.
There has been a major divergence in the growth rates of exports and imports of goods. From July 2020 to January 2021 exports have shown a negative growth of 4 percent. However, there was some recovery in January and exports showed growth of 2 percent. But imports have been growing at 6 percent over the seven-month period. This growth rate has increased sharply to almost 14 percent in January.
Why has there been an acceleration in the rate of increase in imports? One of the principal reasons for this is the jump in imports of agricultural goods. For the first time Pakistan is importing simultaneously wheat, cotton and sugar, along with the usual food items like palm oil, pulses and tea. The result is that the import of agricultural items has increased by over 60 percent. This is a sad reflection of the state of Pakistan’s agriculture. On top of this, there is now the likelihood of the oil import bill going up by over $2 billion in the remaining five months of 2020-21.
Fortunately, the phenomenal growth of remittances has come to the rescue. From July to December, the increase was as high as 25 percent, seldom seen before. It has declined somewhat to 19 percent in January 2021. Remittances from the Middle East, with a share of 60 percent, are beginning to flatten out.
The big question is what factors have contributed to a substantial worsening of the financial account of the balance of payments? The first factor is the big drop in foreign direct investment by 27 percent. Second, from July to January there has been an exit of equity funds of $406 million as compared to a net inflow of $1974 million in the first seven months of 2019-20. Third, there has been an outflow from the SBP of $1467 million, consisting primarily of the repayment of $1 billion to Saudi Arabia.
Fourth, the net inflow into the Government has declined by $ 1,172 million in relation to the level last year. This is due both to lower disbursements of $763 million and higher amortization of $409 million. It is perhaps surprising that debt repayment has increased by over 13 percent despite the debt relief provided by the G-20. This is an indicator of the high underlying growth in external debt servicing obligations.
Overall, the balance of payments in the first seven months of 2020-21 has a small surplus of $717 million, as compared to a big surplus of $5,276 million in the corresponding period of 2019-20. In fact, the month of January has seen a deficit of $565 million in the balance of payments. Consequently, foreign exchange reserves of the SBP declined last month.
The worsening of the balance of payments has occurred at a time when Pakistan is reentering the IMF Programme. Fortunately, the rupee has shown some strength recently. The big question is whether this will persist.
However, there is one major negative development. The rate of increase in the Sensitive Price Index for the week ending 25th of February 2021 has spiraled up to almost 14 percent. Only a few weeks ago it was operating in the range of 6 percent to 8 percent. Since the SPI consists mostly of food items hopefully this does not imply any upsurge in the core rate of inflation. But there is a risk now of the Consumer Price Index rising at a significantly faster rate.
The problem is that if these negative trends in the balance of payments and in the rate of inflation persist then there may be strong pressure by the IMF to take steps to stabilize the economy and prevent any further fall in foreign exchange reserves. This could mean higher interest rates and a big dose of additional taxation in the forthcoming budget, which could jeopardize the insipient process of recovery that is taking place in the economy.
(The writer is Professor Emeritus at BNU and former Federal Minister)
Copyright Business Recorder, 2021