June 7, 2022
ISLAMABAD – Pakistan’s trade terms have remained negative under suppressed exports. Decent the respite sought from an influx of remittances, it is not enough to save us from a persistent current account deficit (CAD) that depletes our foreign exchange reserves. And to save them from drying out, we finance deficits through foreign debt that continues to stack up.
The country is a net energy importer where oil and energy products make up about 25 per cent of the total import bill. The fluctuation of energy rates thus levies a large influence on the state of the economy and the trade balance. Further ramifications trickle down to inflation, currency, foreign exchange reserves, etc. Despite tackling the deficits with monetary and fiscal policy actions, external pressures are largely at the mercy of commodity prices.
Revisiting the circumstances of 2020, when Covid-19 struck, shows us how quickly crashing commodities flipped the odds in favour of Pakistan. Tamed energy prices kept both the inflation and import bill at comfortable levels. Results were striking with a decade low CAD of $1.7bn.
However, post-Covid the world saw supply disruptions and demand stretching beyond capacity. Thus, a commodity supercycle was witnessed.
Annoying the US (which annoys IMF) to save a few billion dollars can cost us arranging external funding of more than roughly $17bn (current account deficit) which makes it an unviable deal
Fast forward to 2022, the heated commodities found new ground in the Russia-Ukraine war resulting in a fresh price run-up. Average coal and palm oil prices, for example, have increased by 2.6x and 1.6x, respectively year-on-year, coupled with an approximately 5x increase in freight prices, which have affected Pakistan’s import bill adversely. Crude oil prices are also up by about 67pc due to which our petroleum group import bill is expected to increase by roughly $8bn in 2022 to about $20bn.
On one hand, commodity prices are through the roof, and on the other hand, crude oil is being offered at a discount by Russia. Geopolitics in the current backdrop has seen the US and its allies impose embargos on importing Russian fossil fuels (Urals) due to the ongoing conflict.
Russia has started to feel the pinch as oil exports are its largest source of revenue. To counter the ban and the reduced exports, it started attracting new countries/buyers by offering them discounts on the Urals. This brings us to the real question; can Pakistan benefit from discounted Urals and save the economy from the doldrums?
The shortest answer is likely yes, but at what cost? In my opinion, the general sense prevailing of massive economic loss from forgoing the Urals is an exaggeration and ignores some ground realities.
Let’s do a cost-benefit analysis, starting by looking at the benefits:
Our petroleum group import bill with current prices is expected to be about $20bn in 2021-22. In the best-case scenario, we would switch 100pc of our energy requirements to Russia, attaining a 30pc discount on our total petroleum import bill. This would have resulted in a saving of $6bn which means a reduction of 35pc in CAD, from about $17bn (estimated FY22 figure) to $11bn.
Although a big relief on CAD, we will still be in deficit and in no way near a surplus given the current global situation. Thus, we will still be required to arrange new loans. Debt will continue to pile up, but the pace will be slower by $6bn.
Let’s put a reality check on this best-case scenario of importing 100% of our fossil fuel needs from Russia; to make a realistic scenario, we can assume switching 50pc of our imports to Russia, resulting in the benefit to cut down by half to $3bn. Now let’s talk about the cost associated with the benefit of $3bn annual import bill savings.
We are running a current account deficit of $17bn which means we at least need this amount of new loan to sustain our thin foreign reserves of about $16bn. This does not include further loan requirements that may arise from debt repayment due in the next 12 months. We rely on the International Monetary Fund (IMF) for such loan requirements. The Fund not only provides loans but acts as a stamp of confidence to other lenders as well making it very crucial for the survival of our economy.
Thus, annoying the US (which annoys IMF) to save a few billion dollars, can cost us arranging external funding of more than roughly $17bn which makes it an unviable deal. Where will we be getting the newer debt from, every year, if we close the doors of IMF and associates is a major question?
Further, there is a worst-case scenario of the cost as well. Buying from Russia can strain our diplomatic ties with the western hemisphere and its allies to the level that we can get defaulted quicker than we think.
Revoking the GSP plus status can affect our textile exports which is the main source of revenue (making about 60pc of exports). Furthermore, we get rollovers on the repayments of debts outstanding which if we stop getting can bring us close to default.
Lastly, any US sanctions, which are less likely, would be a devastating scenario. Clearly, saving a few billion dollars is probably not in the best interest of a nation like Pakistan at the end of the day.
The author is the head of research at EFU Life
Published in Dawn, The Business and Finance Weekly, June 6th, 2022