The industrial package

Budget for fiscal year 2019-20 envisages a major outlay for industry, particularly export oriented sectors, and is a measure of the success of Razzak Dawood, the Advisor to the Prime Minister on Commerce and Industries, to convince Prime Minister Imran Khan to overrule his Advisor on Finance Hafeez Sheikh's reported recommendations based on his adherence, in letter, to the staff-level agreement he forged with the International Monetary Fund (IMF) dated 12 May 2019.
The agreement as per IMF's press release (the two main players representing Pakistan notably Hafeez Sheikh and the State Bank Governor have been silent on the conditions agreed and not yet implemented) includes prior conditions with the following unambiguous statement: "the forthcoming budget for FY2019/20 is a first critical step in the authorities' fiscal strategy. The budget will aim for a primary deficit of 0.6 percent of GDP supported by tax policy revenue mobilization measures to eliminate exemptions, curtail special treatments, and improve tax administration."
Sheikh delivered on the primary deficit target, though the jury is very much out whether the figures he presented in the budget documents are achievable especially in light of the continuing erosion of the rupee vis a vis the dollar - the 150 rupees to the dollar parity used in calculating the mark up allocations for the year as well as customs revenue collections in the budget documents is lower than warranted by the 11 June (budget day) inter-bank rate of 151.40 (bid) and 151.50 (offer); and is much lower than the current rate as well as the future expected parity rate. Sheikh has not been unable to deliver on either eliminating the exemptions or curtailing special treatments. And that is a measure of Razzak Dawood's success.
Be that as it may, the IMF's prior conditions with respect to the State Bank of Pakistan are already in effect - the raising of the discount rate and a market based exchange rate system. The former has raised the cost of capital, which impacts on demand for credit by the private sector, and the market-based exchange rate, so goes the argument, would make our exports cheaper relative to other countries and therefore more attractive. Would these two policy decisions fuel exports, whose decline is attributed to the rupee overvaluation during the Ishaq Dar-led Finance Ministry, reduce imports as they become less attractive and thereby improve the trade imbalance?
The Sharif administration's response to lower exports was to keep the rupee overvalued but to extend a 180 billion rupee export promotion package inclusive of zero-rating to the five main export industries of the country, though Dar did not adhere to the package in either letter or spirit after the budget deficit began to rise to unsustainable levels. His successor Miftah Ismail not only depreciated the currency twice, both times after being urged to by a visiting IMF mission, but also began to implement the export promotion package introduced by Dar and expanded it to include other non-traditional export items.
The rupee depreciated five times between December 2017 and October 2018 and the State Bank of Pakistan spokesperson maintained on 9 October 2018 that the "exchange rate in the interbank market closed at PKR 133.64 to the US dollar, against the previous day's closing of PKR 124.27 to the US dollar This movement broadly reflects the current-account dynamics and also the demand-supply gap in the foreign-exchange market." The Prime Minister disclaimed foreknowledge of the depreciation though his then finance minister Asad Umar stated that he had informed the Prime Minister. Ironically seven months later after the IMF staff-level agreement was reached on 12 May, the Khan administration accepted a market-based exchange rate and since then the rupee has continued to erode in value.
The budget 2019-20 allocates 35 billion rupees under duty drawback of taxes order 2016-17 under the head Development Expenditure Outside Public Sector Development Programme - which was budgeted to receive 10 billion rupees in the outgoing year however was disbursed only 5.7 billion rupees as per the revised estimates. And the Economic Coordination Committee (ECC) of the Cabinet has now approved 3 rupee per unit subsidy on electricity to the industrial sector, and the Ministry for Power is urging Finance Ministry to earmark 80 billion rupees for the purpose for next year no doubt due to legitimate concerns that any rise in the primary deficit from what has been agreed would lead to IMF pressure on the government to meet the shortfall with the axe falling on reducing subsidies. K-Electric has billed 30 billion rupees for the industrial package for the outgoing year with the ECC recommending that this figure be looked into further.
Textile tycoon Motiwala stated that the export incentives must be continued as the industry had "already extended the incentives promised by the government in its export package to overseas buyers in order to ramp up exports."
The question is what has been the impact of the rupee depreciation and the export promotion package on our trade balance.
Pakistan Bureau of Statistics (PBS) trade data reveals that July-April 2017-18 balance of trade was negative 30 billion dollars (with exports of 19.1 billion dollars and imports valued at 49 billion dollars) while the comparable figure for the first ten months of the current year was negative 26.3 billion dollars (exports declining by 0.12 percent to 19.16 billion dollars and imports declining to 45.47 billion dollars or by 7.88 percent).
On 31 May 2019, the interbank rupee dollar parity declined to 148 rupees (buy) and 148.5 rupees (sell) with PBS using the average rupee dollar rate of 145.6922 for May. The July-May trade imbalance for 2018-19 was 29.2 billion dollars against 33.8 billion dollars the year before with exports at 21.26 billion dollars (against 21.3 billion dollars in the comparable period the year before), and imports at 50.4 billion dollars (against 55.1 billion dollars in the same period in 2017-18). The conclusion: the erosion of the rupee has not yet impacted on exports but imports have declined. The government insists that export quantities have increased, though not the value, indicative of the success of its policies. Unfortunately it is the value that strengthens the country's foreign exchange earnings and not the quantity sold. Besides there is no guarantee that the international supply and demand position of our major consumer based items would increase their international prices in future. Dawood has also made much of the trade deal with China which has opened many more tariff lines for sale of Pakistani products in China however he should be aware of the fact that opening tariff lines by China has not increased exports of other countries. Imports on the other hand declined however according to government sources, this decline is due to the completion of phase one of CPEC projects and before the next phase starts imports are expected to rise again.
There is a time lag, as noted by Motiwala, of exports responding to the rupee depreciation as well as the export package. The market-based rupee rate has been effective for a month, not long enough to have had an impact, while the package has been in place for a number of years.
To conclude, there is a need to carefully monitor exports and imports to better determine whether the market-based exchange rate, the higher discount rate and the export promotion package lead to higher exports/lower imports and weigh it against the negative impact on domestic productivity as well as the budget deficit.