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ISLAMABAD: International Monetary Fund (IMF) has urged Pakistan to ink Free Trade Agreements (FTAs) with large, important trading partners to secure market access and further rationalize import tariffs.

According to IMF’s Sixth Review Under the Extended Arrangement Under the Extended Fund Facility, Pakistan’s exporters are facing higher tariffs in Pakistan’s major export markets as compared to the exporters of competing economies, which restricts Pakistani exporters’ competitiveness.

While Pakistan has signed FTAs with China, Sri Lanka, and Malaysia, has preferential trade agreements with Iran, Indonesia, and Mauritius, and is part of the South Asian Association for Regional Cooperation (SAARC), a number of FTAs remain under negotiation or consultation. However, most of Pakistan’s exports are to countries with whom Pakistan does not currently have a FTA. For example, in FY 2021 trade with the United States, United Kingdom, Afghanistan, and Germany (Pakistan’s first, second, fourth, and fifth most important export destinations, respectively) comprised about 37 percent of total merchandise exports, while exports to Pakistan’s 3 FTA markets were about 10 percent.

IMF has observed that absence of permanent FTAs with the major export market destinations hurts Pakistani exporters’ competitiveness as they face higher tariffs than other exporters

The Fund says that Pakistan remains a very closed economy as compared to other Emerging and Developing Economies (EMDEs), with openness quasi stagnating since the 1990s and net exports often acting as a drag on growth. Only a small number of firms export (primarily low value-added textile products) and fiscal revenues continue to rely on import tariffs, undermining trade integration and further weakening export competitiveness.

Pakistan’s exports, which peaked at about 15 percent of GDP in 2003, have been on a declining trend since 2011 and currently stand at about 11 percent of GDP, which is much lower than peer countries. At the same time, export volume growth has stagnated since FY 2007 amid de-industrialization, resulting in a widening export volume growth gap compared to EMDEs. This has contributed to Pakistan’s share of global exports declining by almost 40 percent since the early-1990s to only 0.13 percent of world exports in 2020.

In terms of broad export product categories, Pakistan’s main exports are textiles and clothing, agriculture (vegetables, food products, animal hides), and services, which have all seen limited growth in value during the last decade. The current export basket lacks technological sophistication—products are concentrated in primary products or low-tech undifferentiated products that entail a low level of technology to produce and are on the lowest rungs of the value chains.

Simultaneously, the number of unique products exported has declined. Measured at a HS 6-digit level, Pakistan exported 2,824 unique products in 2019 compared to 2,987 unique products in 2009. This contrasts with many other countries (e.g., Sri Lanka and Vietnam) that have expanded the number of products they are exporting while also moving up the quality and sophistication ladders. While Pakistan is showing some nascent signs of growing its non-traditional exports since 2020-21, they remain a small share of overall exports.

Consequently, net exports have frequently been a drag on growth. This has contributed to Pakistan’s weak medium-term growth prospects, due to the current unsustainable model’s over reliance and re-reliance on consumption and debt-financed investment. Pakistan’s low level of economic complexity suggests that low growth rates will continue unless the country is able to create an environment where a greater diversity of productive activities and more complex activities can prosper, including through exports.

The Fund says that cascading taxes will deter firms from producing more complex products that require more stages of production due to a high tax burden. The high taxes translate into higher export prices and hinder their price competitiveness.

The Fund maintains that historical experience in advanced and EMDEs suggests that exchange rate movements typically have sizable effects on export (and import) volumes. IMF (2015) found that a 10 percent real effective depreciation in an economy’s currency is associated with a rise in real net exports of 1.5 percent of GDP, on average, with much of the effect materializing in the first year. However, the benefits accrue mainly when there is slack in the economy and the financial sector is operating normally. Yet, the benefits accruing to Pakistan are likely to be less, largely due to weak global demand and structural bottlenecks: (i) global trade remains weak, raising price competition, particularly for primary products and low-tech undifferentiated products; (ii) presently only a limited number of firms have export experience, with small and/ or potential exporters unsure of how to access new markets; (iii) some input prices have risen as part of the government’s stabilization plan (e.g., energy prices); and (iv) many firms are also financially constrained and credit is scarce (limited trade credit), which makes it costly for firms to expand production or to begin exporting.

The State Bank of Pakistan has operated an export finance scheme (EFS) with the objective to boost exports since 1973. The EFS provides short-term financing to exporters via banks (commercial and Islamic) for exports of manufacturing goods under two separate facilities: (i) transaction-based facility; and (ii) revolving facility based on the previous year’s exports. The financing is offered at highly concessionary fixed interest rates, for up to 180 days. However, the lending is a commercial decision made by the banks, which are assuming the credit risk. In FY 2021, PRs 700 billion was allocated to EFS—with an additional PRs 90 billion also allocated toward export- oriented investment under the Long-Term Financing Facility—with PRs 565 billion outstanding as of end-June 2021.

Pakistan has relied heavily on import tariffs to boost tax revenue, undermining trade integration and further weakening export competitiveness. With limited revenue mobilization and weak tax administration capacity, the government has relied on import duties and related taxes to raise revenue. As a result, tax revenue collected at import stages stands at about half of total tax revenue. Although Pakistan has reduced tariffs during the last decade, its tariffs remain relatively high compared to most EMDEs. The high effective protection has resulted in long-protected “infant” industries preventing their development, reducing the incentive to compete with imports and need to export given their protected, privileged domestic market position.

IMF has advised Pakistan to continue to work to further rationalize the tariff structure as part of implementing the approved national tariff policy, based on time-bound strategic protection. As domestic tax revenue mobilization strengthens, there will be space to rationalize tariffs in line with international practices, which should aim for low tariffs at uniform rates.

Copyright Business Recorder, 2022

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