The Pak China Free Trade Agreement will result in Current Account Deficit
A coordinated approach should have been taken to make the most of this FTA.
The free trade agreement signed with China came into effect on Jan 1, 2020
It added 313 more items to 724 items that were already allowed to be imported duty free into China. Did any one wonder what is Pakistan exporting out of those 724 items that are already duty free?
Recall in the first phase of the agreement, Pakistan had zero-rated duty across nearly 3000 products, of which 95 percent were items where Pakistan never exported in throughout the five years the agreement remained operational.
What about 313 new items that are added to the list. As it turns out, half of the items have never been exported by Pakistani exporters anywhere in the world thus we do not know if we can compete in these items.
The 313 tariff lines across which Pakistan enjoys zero duty access in China immediately does not seem to be a carefully curated list. In fact, it contains items which Pakistan has never exported to the world ever before. Such items are 48 percent that makes up the entire 313 item list. If Pakistan has never exported nearly half the items anywhere in the world, these items are unexplored. Will the sudden concession make them competitive? Does Pakistan even have the capability to produce and export these items? Did the industry contribute to creating this list, because after all, it is the industry that will be making this “exportable” products?
Of the $867 million total Pakistani exports to China across 313 tariff lines (in 2018), nearly 70 percent of that amount comes from exporting just one product in that offer list (HS 52051200: uncombed cotton yarn). Another curious observation: the top 24 items in the list (by dollar value) consist of only cotton and value-added textile products (aside from one item: cement). Of total exports to the world across these 313 items, these 24 items took up 81 percent of the share.
Makes you wonder what the commerce minister is on about below. Unless the base is very low and multiplying it by 20 doesn’t move the needle much.
One can argue that though we don’t have the capacity now, we will import manufacturing equipment and set it up to export exportable goods to China.
This will initially result in increase in imports which will lead to a current account deficit. Hence, a current account deficit isn’t so bad. This is lost on all the CA surplus celebrating crowd. If it is decrease in fuel and input materials that are used in export industry, such a reduction in current account deficit shouldn’t be celebrated as it implies that economy is slowing down. But I digress.
It was known for sometime that Free Trade Agreement will be coming into effect in January 1, 2020. This means that private sector should be gearing up to set up the industry and borrowings should have increased.
Turns out private sector borrowing is tanking. The below chart is from latest IMF report.
One can argue that private sector is sitting on surplus cash and they will be using that cash instead of borrowing to set up export industries. Again IMF data contradicts it. Contribution of industry to GDP is shrinking. Unless the plan is to export services to China, which doesn’t require the current FTA as it only covers goods.
IMF and local financial institutions as well as industrialists blame high interest cost of borrowing on fall in borrowing. I will not dwell on it because Raza Baqir fan club takes it personally if I criticize the high discount rate to attract foreign portfolio investments in T-bills. It has been explained to me that high discount rate doesn’t matter__ subsidized rates of financing are available for export industries and SMEs don’t borrow thus discount rate is irrelevant. No one explains that if it is irrelevant, then why it has been increased to 13.25%. At a very low spread of 2%, an industrialist must have a very optimistic outlook if he plans to borrow at 15.25% to set up an industry but I digress.
As both private sector credit and industrial contribution to GDP has been decreasing for a while, it is almost certain that private sector hasn’t made any SPECIFIC investment in last year to target the goods in the FTA list.
I came up with 5 hypotheticals to explain this conundrum to myself:
- Private sector is shit at planning.
- Private sector didn’t believe that FTA will come into effect and didn’t invest a dime till it comes into effect. Says a lot about lack of credibility and trust in the government.
Anyway all is not lost. The private sector can start investing now which will result in a temporary current account deficit but once the production comes on line, it will result in increase in exports to China with current account deficit turning into current account surplus. This will take some time and thus benefits may only be visible after a few months.
3. Best case scenario: private sector already has the capability to produce such goods and has a slack in production capacity. What they lacked was access to market. Now that the market is open, they will push the start button on the manufacturing plant and start exporting from tomorrow.
4. Worst case scenario: private sector has no intention to enter the highly competitive Chinese market. As they are mainly exporting cotton yarn out of the 1000+ on the FTA list, they may just select a few low value added items out of the new list and export those to much applause.
5. The FTA was never for the locals to invest but Chinese relocating production plants to Pakistan to export goods back to China. There are two aspects to it:
- Chinese have been relocating to Bangladesh and Vietnam due to their low labor costs. Labor costs in Pakistan are still higher than Bangladesh and we will need to reduce labor costs further in Pakistan (more devaluation?) if we want Chinese to relocate to Pakistan due to labor productivity. FTA alone wouldn’t help neither will the 13.25% discount rate.
- Are Chinese incapable of planning like our local businesses? They waited for FTA to come into effect before they will start investing in Pakistan as Umar Mansha said to Dawn
I don’t see Chinese firms relocating their manufacturing units to Pakistan. If they wanted to relocate here, what could possibly have stopped them until now? And why would they invest in Pakistan?
The government has been touting SEZs at every forum but there hasn’t been much progress on this front either. This is from yesterday’s Business Recorder titled Zoned Out
Even after all nearly five years of marketing hype, promises and hopes, most of Pakistan’s special economic zones do not even have basic utilities of electricity and gas. Even Faisalabad SEZ’s where nearly 570 out of about 582 plots have been bought by businesses, there has been no construction (save for a handful of companies) due to lack of utilities.
Only more recently has the federal government decided to fund projects through PSDP to supply electricity and gas to some of these SEZ, and reportedly PC1 and funding of these projects are a few weeks away. But if Pakistan has to compete in the global SEZ space, it will have to offer far more than just basic utilities.
Conclusion
There is a clear disconnect between government, industry and SBP. A holistic approach is required if we plan to not let this crisis go to waste. Already, lack of coordination and planning has resulted in government spectacularly failing in case of Pakistan Banao Certificates despite all the fist pumping and backslapping
while Naya Pakistan Housing is also on its way to failure
Caveat
The analysis is based on publicly reported data. If the ground realities are different, analysis doesn’t hold.
