In a recent interview, the former Finance Minister, Miftah Ismail,advanced a notion that Pakistan's economic woes could be resolved by increasing exports by $20 billion. This proposition prompts a crucial inquiry: would this remedy indeed alleviate our economic challenges if it led to a corresponding rise in imports of equal or greater magnitude? One cannot dismiss the potential resurgence of a current account deficit as imports escalate, possibly by $40 billion or more. The question thus arises: did our substantial curtailment of imports in the last few years genuinely yield any substantial improvement?

Miftah Ismail's stance isn't an isolated perspective. Over the recent years, a clamor around the current account deficit has echoed amongst financial managers and economic pundits alike. The prevailing consensus among these opinion leaders suggests the pursuit of a nationalistic policy involving import tariffs, export subsidies, and protectionist measures. A common observer of television broadcasts might conclude that only exports hold the key to a nation's prosperity while imports stand as a threat to its very way of life. Trade deficits are portrayed as the road to economic destruction.

This line of thinking corresponds to a school of thought known as mercantilism. This doctrine strives to avert potential current account deficits or to achieve a current account surplus, employing tactics aimed at accumulating monetary reserves via a positive balance of trade. While comprehensible, it's no wonder that many individuals are swayed by this perspective, perceiving trade as a competition centered on exports and harboring suspicions that other countries inflict harm by providing us with quality goods at a reasonable cost. This palpable misunderstanding fuels the fervor around import substitution, irrespective of production quality and opportunity cost considerations.

To delve deeper into this perspective, consider a hypothetical yet illustrative trade example. Imagine a scenario where we discover intelligent life on Mars, prompting us to export wheat, rice, and vegetables to this celestial sphere due to their inability to cultivate these crops. One might wonder: what's our gain in this trade when the exported crops effectively mean they can't be consumed by us? Would we truly benefit from such trade? After all, it represents the ultimate dream of a trade surplus. The answer is no. Our actual gain from this trade scenario hinges on receiving something in return that we value more than the goods exported — perhaps precious minerals. In the realm of trade, the true advantage stems from imports, making exports nothing more than a cost required to obtain those imports. The same principle resonates within international trade among nations: exports facilitate the acquisition of imports, which is the ultimate objective. It allows us to import items that are either difficult for us to produce or at least challenging to produce at a low cost. The emphasis invariably rests on maximizing the value of imports.

Then, why is a trade deficit often perceived as problematic? In truth, a trade deficit poses no inherent issues, as trade is primarily about imports, not exports. Managing the current account deficit lies beyond the purview of the government; it’s a solution trying to find a problem. Trade occurs between private individuals and enterprises, and the government should refrain from financing consumer preferences, much like it refrains from financing the foreign debt obligations of private businesses.

In instances where imports surpass exports, equilibrium is restored through adjustments in the exchange rate. Regrettably, governments are consistently preoccupied with either controlling or exerting influence over the exchange rate, much like they do with various other essential commodities. Ironically, many of those who endorse price controls on commodities passionately advocate for a free-market approach concerning exchange rates, perhaps persuaded by the clearly evident outcomes in this particular situation. However, market includes two components: demand and supply. So, restricting imports is still a market manipulation and does more harm than good.

Politicians often highlight export figures as a yardstick of success, acting as if these numbers must be attained at any cost. The notion of using subsidies is thus put forth as a mechanism to bolster competitiveness. However, international trade is not a competition for exports, it’s a cooperation. Just as trade with our local grocery store is not a competition. When governments extend subsidies, they essentially prioritize the interests of specific groups, usually consumers, which enhances their welfare at the expense of broader societal economic welfare. Subsidizing exports takes this a step further, amplifying the welfare of foreign consumers at the expense of domestic welfare. Such a situation is inherently lose-lose and ultimately favors export-oriented companies that are inclined towards seeking special privileges, a trend that has been unfolding.

Furthermore, there's a growing obsession on import substitution, yet a pertinent question remains: at what cost? One must first probe why certain products are not domestically manufactured or grown. Often, the reason is their elevated cost or inferior quality. Would anyone willingly purchase an inferior product at a premium price and feel content? The goal should not involve rejecting cost-effective imports to manufacture everything domestically. Pursuing self-sufficiency leads down the path to impoverishment. If China offers us superior products below cost, the sensible response is to welcome these imports with gratitude. There is no good reason why we should object to the foreign aid that we can receive through the imports subsidized by the Chinese government.

This brings us to the crux of the matter: the actual predicament. As previously explained, a current account deficit is not a problem at all. The true challenge lies in the government's incapacity to honor foreign debt obligations due to its fiscal imprudence and its inability to broaden the tax base. Undoubtedly, it presents a significant concern of utmost national consequence, requiring a host of governmental actions to ensure the sustainability of debt payments. However, addressing the current account deficit is not among these necessary measures.

Before making any decisions, it's imperative to embrace and acknowledge the hard-hitting economic realities at play. The gradual adoption of free trade and a market-driven exchange rate holds the potential to strategically harness our comparative advantage. This, in turn, would allow us to manufacture a specific product or service at a significantly reduced opportunity cost compared to our trade partners. Rather than being fixated on the production of costly goods for local consumption or camouflaging the costs of exported items through subsidies, the focus should pivot to reducing business costs by removing unnecessary obstacles, facilitating the unimpeded flow of capital and resources into sectors where our comparative advantage thrives.

Consequently, such a stance would set the stage for market dynamics to organically shape the economic landscape, liberating resources from wasteful rent-seeking and inefficient high-cost production. Ultimately, consumers would reap the rewards by gaining access to the best bargains from every corner of the world, while exporters could reap sustainable profits and heightened productivity without depending on subsidies or hampering national economic welfare.

As a transaction of otherwise legal goods, smuggling is no different than trade, except that there is no government involved in this, at least in its formal and institutional meaning.

Smuggling provides a solution against excessive government intervention in the form of tariffs, excise duties and border closures. Smugglers provide us signals and offer information about policy distortions.

If smuggling of any product is on the rise, it implies that tariff rates in the case of imported goods and excise duties in the case of locally manufactured items have been set too high compared to prices of similar goods available in bordering countries.

It is well acknowledged that Pakistan’s import taxation (customs duties, additional duties, advance income taxes, advance sales tax, etc) results in probably the world’s highest ratio of import taxes as a percentage of total taxes collected in the country.

This poses a significant barrier against competitive products, which depend on competitive prices. Effectively, this import taxation system is a tax on exports.

Another way to look at smuggling is the impact of increase in excise duties on products made in Pakistan. A notable rise in excise duty usually leads to increase in the flow of illicit goods – cigarettes are the case in point. Last year, a significant rise in excise duty led to increase in prices and hence the inflow of illicit and counterfeit products.

Pakistan has already seen results of a complete ban on imports, which proved to be disastrous for productive and export sectors of the economy, while bringing short-term advantage in terms of reduction in trade deficit.

While large and formal firms were badly hit by these general restrictions on imports, the small and medium-scale enterprises increased their reliance on imports through informal means, ie smuggling. This led to a decrease in collection of customs revenues as well. Smugglers came to the rescue of SMEs.

Recently, a significant increase in smuggling has been observed in the case of petrol. If we allow Iranian refineries to sell petrol directly to Pakistan, the smuggling of petrol will vanish in one day.

Let’s now consider smuggling of currency. Our former finance minister believed that dollars are being smuggled in huge quantities, causing its appreciation. It is correct that there were a couple of successful raids in which dollars were forfeited, however, it should not be generalised. But for a moment, let’s assume he was right.

A sudden rise in dollar smuggling, if it happened, also signalled that the policy created arbitrage opportunity, which then increases the physical flight of dollars. Thus, once again, smugglers provided a signal to policymakers.

We now know clearly that the difference between open market and inter-bank rates was a signal of policy gap itself.

In a country where incomes are not rising whereas prices are on an upward spiral, smuggled goods, often less costly than “taxed goods”, offer an alternative to low-income households as well as street vendors. We see this in many large-scale markets.

Let’s take the recent seizure of NLC trucks where sugar was being “exported” in the name of other goods.

This also occurred because the government refused on-time permission to industrialists to export sugar, which was trading at a much higher rate before the world market crashed. Thus, the traders who were using those trucks also signalled a policy correction.

Whenever we hear about smuggling, the recommendation is to always take strict enforcement measures on borders, by increasing surveillance and security check posts in border areas.

In a system, where such security arrangements can be breached or rather purchased easily, these policies only increase the cost of goods but do not reduce the quantum of smuggled goods.

In Pakistan’s social system, it is often observed that smugglers become very religious and perform pilgrimages. Smugglers should indeed be rewarded for their service to economic and policy systems.

This Article was originally published in The Express Tribune on September 11, 2023.

Last week, I had the opportunity to visit two large factories, both operating within special economic zones, supplying goods for the international market while creating job opportunities and fostering technological advancements for the domestic market. These firms operate in competitive global markets and serve as prime examples of the untapped potential that lies within Pakistan, encouraging investors to kickstart businesses. In this article, I will delve into the factors hindering our ability to generate sustained economic growth in the country, while drawing insights from these successful examples. This discussion is imperative given the concerted efforts by the country’s leadership, both civil and military, to encourage foreign investments as a means to bolster our foreign exchange reserves.

First and foremost, let’s take a look at the bigger picture. Pakistan was on the verge of default not too long ago, until a high-level discussion between Pakistani, US, and International Monetary Fund (IMF) leadership culminated in another IMF assistance package, the Stand-By Arrangement, providing a short-term financial boost of $3 billion. While the IMF diplomatically states that this programme “builds on” efforts under the Extended Fund Facility (EFF), it is evident that the EFF fell short—a failure that both IMF and Pakistan must acknowledge and shoulder.

A more accurate summary would attribute this shortfall to “policy missteps.” The major blunders were the restrictions imposed on imports and interventions in the forex market—measures that did more harm than good. While Pakistan may have saved $10 billion through these actions, it ended up losing even more through reduced exports and remittances. Importantly, these actions eroded the confidence of Pakistan’s existing private sector.

There’s a consensus that Pakistan lacks the necessary foreign exchange reserves to meet its external obligations. Our sources of foreign exchange—exports, remittances, and foreign investment—consistently fall short of requirements, leading to a perpetual balance of payment crisis, compelling successive governments to seek assistance or loans. The objective has always been to maintain foreign exchange reserves equivalent to at least three months’ worth of imports. While external inflows such as debts, rollovers, and aid provide temporary relief, the underlying issue remains unresolved, and we continue to kick the can down the road. However, the roadblock we encounter each time seems to get larger, as seen in the recent accumulation of reserves through roll-overs, loans, and aid.

Enter “Plan B,” recently unveiled as an alternative strategy. This plan aims to attract foreign exchange through inter-governmental transactions, wherein the Government of Pakistan (GoP) can sell, lease, or outsource its assets to international players to raise capital. The Pakistan Sovereign Wealth Fund is a key component of this strategy, encompassing at least seven state-owned enterprises (SOEs) with assets totalling Rs2.3 trillion or $8 billion. Once enacted, these SOEs will be exempt from the Privatisation Commission, SOE Act, and Procurement Act. The Fund’s shares and management will be presented as investment opportunities to “friendly countries.” The potential costs and benefits of these inter-governmental deals remain shrouded in official secrecy.

Yet, an alternative roadmap exists—a “Plan C” or rather “C2,” where C signifies a “Capitalist Charter.” This roadmap has three main pillars: low taxes, open trade, and a level playing field. Businesses operate to earn profits, and in a country where corporate taxes consume over 50% of income, genuine investments are hard to attract. We need to significantly lower income tax rates for businesses and salaried individuals while streamlining exemptions and raising thresholds. An effective tax policy could serve as a powerful investment policy if it guarantees a low rate for a 10-year span. Alongside reduced taxes, the country must rationalise and decrease tariffs, encompassing all forms of import taxation. No other country relies on tariffs to the extent that we do for revenue. A regime of predictable, low tariffs aids businesses in planning production and inventories. Import restrictions should never again be employed as a tool. Lastly, fostering a business-friendly environment entails eliminating unnecessary hurdles and roadblocks, ensuring a level playing field for all enterprises. The state and its institutions should collaborate with, rather than compete against, the private sector.

This “Plan C” holds more promise than both “Plan A” (IMF) and “Plan B” (Sovereign Wealth Fund or Special Investment Facilitation Council (SIFC)). “Plan A” has faltered, and “Plan B” is unlikely to deliver sustained and inclusive economic growth. We must work alongside Pakistan’s homegrown entrepreneurs and capitalists. To create a credible alternative to the state-linked elite, we need to cultivate a counter capitalist elite that isn’t reliant on state largesse. This transformation begins with reducing the state’s scope and preventing its expansion into the private sector. 

This Article was originally published in The Express Tribune on August 07, 2023.

ISLAMABAD: It seems that the caretaker cabinet is setting its eyes on the future instead of just steering the country through next general elections.

There are two statements made by caretaker Minister of Commerce and Industries Gohar Ejaz, which make me think this way.

He has recently called for establishing new business parks “to consolidate Pakistan’s global trade connections. These parks or facilitation centres for traders would be designed to serve as hubs for foreign traders, enhancing trade relationships and driving economic growth.” He believes these business parks are good for trade connectivity.

Ejaz has also announced an export target of $80 billion and a “new” strategy of targeting specific countries and by devising a new trade policy framework.

This is wrong on a number of grounds. First of all, the caretaker cabinet should not be allowed to make any pronouncements with long-term consequences for economic policies.

Setting up new business parks or devising new trade policy frameworks are ambitious undertakings.

Similarly, following an export target of $80 billion from the current level of $40 billion is a very ambitious plan. It is unrealistic to achieve it within the period for which the cabinet has sworn in.

The appointment of an industrialist on a public position is also a serious conflict of interest. Public position holders, even if they are financially honest, become privy to critical information much ahead of time that they can easily use to gain private benefits, even if these gains are to materialise in the future.

A caretaker government for three months or six months cannot be taken seriously by investors and diplomats who are looking for a long-term and stable political outlook. In fact, one wonders if this should be taken too seriously by members of the cabinet themselves.

A best caretaker government is no caretaker government. There is hardly any country in the world which practices this arrangement. The sitting government continues till the holding of elections and transfer of power whereas the Election Commission is much more empowered.

If the caretaker government continues for an extended time period, as it is generally believed, till March 2024, then their main mandate is to ensure that Pakistan is not worse off than it is today in terms of economic stability.

That means, primarily, stabilisation of exchange rate, which demands keeping the forex market free from any kind of intervention. This, in turn, is the function of central bank, and not of the federal government, which should continue to exercise its constitutional mandate.

There is another news recently that electricity distribution companies will be handed over to provincial governments. While the caretaker government does not have a mandate to take such a decision, the transfer to provincial governments is hardly going to be a solution.

The solution lies in creating competition in the electricity distribution market and not in “provincialisation” of DISCOs. However, it will help in reducing the federal government’s budget deficit as a significant chunk of subsidies is allocated for the power sector.

Expectations have been built that the caretaker government will take some “tough” economic decisions which elected governments usually hesitate to undertake.

While political governments may be happy to pass on the buck to an interim setup, this does not solve fundamental issues that require consensus on restructuring and reforms.

One of the long-term challenges that Pakistan will have to face is its debt management. As the IMF standby arrangement continues to hold, there should be public discussion on various options for Pakistan’s next government including that of debt restructuring coupled with economic reforms.

The debate can help guide political parties in formulating their manifestos as they prepare for next general elections.

This Article was originally published in The Express Tribune on August 28th, 2023.

Pakistan has a rich history of state-run enterprises marred by inefficiencies and lackluster performance. There is a plethora of challenges that have hindered their growth and effectiveness. Bureaucratic red tape, political inteference, misaligned incentives, and inadequate accountability mechanisms have contributed to a lack of agility and innovation within these organizations. As a result, their ability to adapt to changing market dynamics and technological advancements has been severely compromised. 

Such inefficiencies not only stifle the potential for these enterprises to flourish but also strain the nation's economy, leading to wasteful allocation of resources and diminished competitiveness on the global stage. While the prevailing discourse among policy makers and opinion makers leans towards endorsing the state's involvement in running profitable enterprises, it is essential to critically examine the potential ramifications of such a proposition. 

Advocates of a balanced economy often argue for a mix of state-owned enterprises (SOEs) and private sector involvement. Some contend that past privatization efforts in the 1990s did not yield the expected benefits for the country, and they maintain that profitable SOEs should not be privatized at all. While this argument may hold merit when considering accounting profits alone, it overlooks the critical concept of economic profit and the accompanying opportunity costs that are invariably at play, whether consciously acknowledged or not. 

Privatization facilitates optimal allocation of resources, improved service quality, and enhanced efficiency, ultimately driving economic progress. A prominent example of successful privatization in Pakistan is evident in the banking sector. Private banks have surpassed state-owned banks in terms of return on assets (ROA) and return on equity (ROE), leading to heightened efficiency and profitability. 

Let us examine the case of the National Bank of Pakistan (NBP), a state-owned bank. NBP recorded an after-tax profit of 30.4 billion rupees last year and has consistently demonstrated commendable profitability over the years. On the other hand, the Muslim Commercial Bank (MCB), once state-owned but privatized in the 1990s, achieved an after-tax profit of 32.7  billion rupees and maintained an equally good track record of profitability. At first glance, both banks appear to be performing equally well, with nearly indistinguishable profit figures. However, this simplistic view fails to consider the opportunity costs arising from inefficiencies. 

When we examine the return on assets (ROA), a measure of how efficiently a bank utilizes its assets (mostly cash for banks) to generate a profit, MCB clearly outperforms NBP. MCB's average ROA is more than twice that of NBP's. Considering this significant disparity in ROA between the two banks, the opportunity cost incurred amounts to approximately 42 billion rupees in the last year alone, with an accumulated opportunity loss of 261 billion rupees over the past decade. These figures are substantial and demonstrate the necessity of considering the economic efficiency of SOEs beyond their superficial profitability. To put these numbers in perspective, the entire market capitalization of NBP currently stands at approximately 43 billion.

Indeed, we must not overlook the fact that a larger asset base can potentially limit a bank's ability to achieve equally impressive profits. However, it is crucial to recognize that the situation is even more concerning when it comes to smaller state-owned banks, which are performing even worse in comparison. The stark contrast in performance between private banks and state-owned banks becomes evident when we consider the average returns on their assets. 

While some may argue the need for government involvement in running profitable SOEs, the argument for privatization becomes irrefutable when dealing with loss-making entities like Pakistan International Airlines (PIA). The accumulated loss of PIA, which now stands at a staggering 651 billion rupees, poses an alarming financial burden for the government and taxpayers alike. Such a colossal loss cannot be ignored. To illustrate the opportunity cost at hand, the amount is equivalent to providing wheat supply for approximately 37 million impoverished individuals for an entire year. This staggering figure underscores the opportunity cost of maintaining PIA under government control and  highlights the potential to redirect these funds towards initiatives like poverty alleviation and infrastructure development. 

In conclusion, the successful path forward lies in embracing privatization to unlock the true potential of SOEs. By reducing the government's grip on businesses, the country can harness the power of market forces to drive economic growth, allocate resources efficiently, and foster prosperity for its citizens. To achieve this, policymakers must fully grasp the concept of economic profit, recognize the opportunity costs associated with inefficiencies, and prioritize the long-term benefits that privatization can bring to the country.

Prior to the creation of the SIFC, these objectives fell under the purview of various bodies, ministries, and institutions including the Board of Investment, Council of Common Interest, Prime Minister’s Office, Ministry of Industries, Ministry of Finance, State Bank of Pakistan, Ministry of Commerce, and Economic Coordination Committee of the Cabinet. The inclusion of the army chief in this apex body is the most noticeable change, with the prime minister attributing economic revival and the International Monetary Fund (IMF) Standby Agreement to the army chief.

The stated goal of the SIFC is to generate $20-25 billion through foreign direct investment (FDI) in order to avoid a dollar shortage without incurring additional debt. While the goal is commendable, it is worth revisiting the latest success story of investment in Pakistan – the China-Pakistan Economic Corridor (CPEC). We can argue on merits and demerits, but CPEC remains the single largest Belt and Road Initiative (BRI) investment package in the world.

Two models of Chinese investment in recent years serve as examples, excluding the debt portion.

The first model is seen in the CPEC power projects, where investments were made in power generation with guaranteed returns on equity, backed by sovereign guarantees and capacity payments. Revenue is generated from users who pay in Pakistani rupees, while the government arranges dollar payments to independent power producers (IPPs). However, this model carries foreign exchange and non-utilisation risks. We have experienced both locking us into continuously rising circular debt, which has now spiked to $10 billion already only in the electricity market.

The second example involves Chinese investment in Pakistani industry, aimed at increasing productivity, production, job creation, and export income. Earlier, the news reported a Chinese company’s plans to invest $150 million in an industrial park on Lahore’s border with Kasur. It is said to house state-of-the-art fabric units, dyeing facilities and garment manufacturing units to export sportswear from Pakistan to the Americas, Europe, Asia-Pacific and other regions of the world. However, such investments in the private sector are rare, with most Chinese investment focused on energy and infrastructure projects managed or backed by the government.

The demand from China to relocate textile industries to Pakistan is evident, but it requires swift action and a favourable environment for setting up operations. These firms can’t wait for years to acquire land, get utility connections and clear all the red tape.

According to a report by the Pakistan Business Council (PBC), Islamabad has not been successful in leveraging CPEC to catalyse domestic private investment or attract non-China FDI.

The Chinese investment in power projects is driven by two models. The first model aims to tap into a large and growing consumer base in the market, with the state providing financial backing. However, under this model, we will end up paying more dollars than we receive, regardless of the success of the investment project.

The second model focuses on increasing local capacity to enhance exports and gain a larger share in the international market. With this model, we not only receive dollars through exports but also have the opportunity to repay investors based on the success of the project.

It is crucial for Pakistan to refrain from further infrastructure projects unless there are public-private partnership agreements that do not burden the country with more debt or convert investments into liabilities. Joint ventures within the private sector should be explored instead.

This is primarily Pakistan’s problem and not that of the IMF, creditors, or friendly countries. The debt issue stems from misaligned fiscal policies, bureaucratic red tape, and irresponsible practices of the federal government. Without a radical transformation of the economic policy landscape on the ground, high-level committees will yield little results. Credibility in profit repatriation promises cannot be established if repatriation is halted for extended periods. These counterexamples highlight the need to invest in the foundational pillars before constructing buildings.