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December 4, 2020

Managing the economy


December 4, 2020

For successful economic diplomacy, Pakistan will have to work out its trade policies, domestic distribution of foreign economic assistance, product sophistication and diversification, and business environment.

For starters, Pakistan will have to get the finance and commerce ministries to boost trade and discontinue the current practice of using trade policies to address fiscal deficits and revenue shortfalls.

The Ministry of Finance, including the Federal Bureau of Revenue (FBR), undercut the dividends of Pakistan’s external economic engagement in two ways. The finance ministry borrows from foreign commercial banks or diverts the foreign economic assistance potentially destined for infrastructure, agriculture, education and health sectors to address the fiscal deficits, improve balance of payments, finance commodities such as oil form the Middle East, or for debt repayments.

This in turn leads to inequitable and unfair distribution of invaluable foreign funding and leaves the country’s human development challenges largely unaddressed.

On the other hand, the FBR fails miserably in its basic job responsibilities of generating revenue through collecting taxes, including through widening the tax base, and instead trespasses on the territory of the Ministry of Commerce to set tariff rates and employ import tariffs to fix the fiscal revenue gap.

In short, Pakistan’s trade policy is rendered subordinate to finance and taxation policies, and import tariffs are employed as an instrument of revenue-generation in lieu of conducting trade.

The FBR’s heavy reliance on import tariffs has resulted in the highest weighted average tariff rates in Pakistan as compared to other countries with annual exports of over $20 billion. Where the global weighted average stands at 2.7 percent, South Asian 5.9 percent, ASEAN 2.5 percent, China’s 3.8 percent, and India’s 5.8 percent, Pakistan’s average has varied between 11 and 13 percent for the past several years.

Pakistan does not seem to have learned from its history of the severe impact of high tariff rates on the level of exports and overall economy. In the year 2000, when the country’s weighted average tariff (WAT) was 23.1 percent, exports were worth $2.9 billion only. As the WAT reduced to 8.9 percent in 2014, the country’s exports increased to the highest level of $25.1 billion (an increase of 173 percent).

Successive governments, however, reversed the course of tariff liberalization and applied increasingly more tariffs. As the WAT reached 11.6 percent in the FY19, exports also witnessed a slide to $23 billion.

Currently, 48 percent of Pakistan’s total tax revenue comes from import tariffs, in contrast to that of the export-oriented economies of Malaysia (1.6 percent), Turkey (2.4 percent), Indonesia (2.6 percent), South Korea (3.2 percent), China (3.9 percent), and India (12.8 percent).

The heightened tariff rates have increased the cost of imports, which in turn has dented industrial competitiveness by protecting inefficient producers, who then become less export-oriented and manufacture goods for domestic consumption.

As a result, the share of industrial production as a percentage of GDP has decreased from 26.4 percent in 2010 to around 18 percent in 2019, and the contribution of exports to GDP has declined from 13.5 percent in 2010 to only 7 percent in 2019.

This demonstrates how merely a structural distortion in the role of the finance and commerce ministries affects the overall economy of a country. The other problem identified at the start is the unfair management of foreign economic assistance coming from development partners in the form of bilateral and multilateral financing.

In FY20-21, the total foreign inflows for Pakistan were $2.7 billion, of which only $317 million (12 percent) was allocated for projects financing, whereas $1.4 billion (46 percent) was appropriated for budgetary support, $1 billion (37 percent) in terms of time safe deposits, and $0.14 billion (5 percent) to repay foreign commercial loans. The largest chunk of foreign development assistance that could go for education, health, poverty alleviation, water management and agricultural development was redirected to meeting fiscal and balance of payment deficits.

It is then no surprise that the country’s development partners are presumably frustrated at seeing their funds being spent on fiscal and current account payments instead of improving human development indices, adding more electricity to grid stations, or transforming the agriculture sector from subsistence level to commercially engaged.

The third issue in Pakistan’s external economic engagement is the lack of product sophistication and diversification, and a vision for a diversified market access.

Nearly 70 percent of Pakistan’s exports comprise cotton manufactures and agriproducts. On the contrary, advanced economies export highly sophisticated products like automotive manufactures, telecommunication, electronic data processing, integrated circuits, and pharmaceutical goods.

In the post-Covid-19 era, many advanced economies are also shifting to providing technologically driven digital services.

The 2019 Global Competitive Index rated Pakistan at the lowest in South Asia at 110th, whereas India stood at 68th, Sri Lanka 84th, Bangladesh 105th, and Nepal 108th. The major reasons for Pakistan's lack of competitiveness and inability to sophisticate and diversify its products and markets are the inefficient production technology and skills, failure to meet international quality/quantity compliance requirements, dearth of research and development, and increased cost of exports and imports.

These are the very reasons that Pakistan has failed to increase its exports even after having free trade agreements with the advanced economies of China and Malaysia, and the preferential trade agreement with Indonesia. Due to the lack of product sophistication and diversified mix of tradable commodities, other advanced economies like Australia, Japan, and South Korea find it difficult to sign free trade agreements with Pakistan.

Pakistan’s Look Africa Initiative may be more of a sign of having uncompetitive and unsophisticated products than a diversified vision of economic diplomacy, which would otherwise prioritise immediate neighbourhood in South and Southeast Asia and the Indo-Pacific region.

All in all, Pakistan’s external economic engagement is not just beset with the challenge of rectifying trade and finance policies, but also that of focusing on product sophistication and diversification and diverse market access, and reducing strict -- and often ambiguous -- regulations as well as ensuring protection of intellectual property rights.

The writer is a research associate at the Center for International Strategic Studies (CISS), Islamabad.

Twitter: @Riaz1Khokhar