Deficit Balance of Payments, Causes and Control

Introduction:
Balance of payments (BOP) is a record of economic transitions between the residents of one
country and the rest of the world during one year. The balance of payment like all balance
sheets must balance. The items, which lead to, an inflow of foreign earnings are placed on the
credit side of the balance sheet, whereas the items, which give, rise to an outflow of foreign
currency are placed on the debit side.

Definition:
“Balance of payment is a systematic record of a nation’s total payments to foreign countries,
including the price of imports, the outflow of capital and gold, and the total receipts from
abroad, including the price of exports and the inflow of capital and gold.”

Terminology of Balance Of Payments

In balance of payment the credit is Exports, while debt is Imports.
If the Exports exceed Imports we call it trade Surplus.
A balance of payments surplus means the country exports more than it imports. It provides
enough capital to pay for all domestic production. The country might even lend outside its
borders. the Exports exceed Imports we call it trade Surplus.
A surplus boosts economic growth in the short term. There's enough excess savings to lend to
countries that buy its products. The increased exports boost production in its factories,
allowing them to hire more people. In the long run, the country becomes too dependent on
export-driven growth. It must encourage its residents to spend more
If the imports exceed exports we call it trade deficit.
A balance of payments deficit means the country imports more goods, services and capital
than it exports. It must borrow from other countries to pay for its imports. In the long-term, the
country becomes a net consumer, not a producer, of the world's economic output. It will have
to go into debt to pay for consumption instead of investing in future growth. If the deficit
continues long enough, the country may have to sell off its assets to pay its creditors. These
assets include natural resources, land, and commodities.

If the exports equal to imports we call it trade Balance.

Components of Balance of Payments
The main components which are included in the balance of payments are given below:

 CURRENT ACCOUNT
 CAPITAL ACCOUNT
 RESERVE ACCOUNT

Current Account: consist of four main components,

 Trade balance: sum of exports and imports of Merchandise goods.
 Net services balance: sum of receipts and payments on exports and import of services
such as travel, freight, insurance, transportation, etc.
 Net income balance: sum of all receipts and payments on interest on loans, profits,
dividends, royalties, etc.
 Current transfer: sum of all private and official transfers such as worker remittance
through banks, receipts through exchange Companies, foreign currency deposit of
residents.

Capital and Financial Account: consist of sum of all foreign direct and portfolio
investment, foreign long medium and short term loan repayments of principles and
disbursements of loans, foreign currency account of non residents.

Reserve Account: It shows the foreign exchange position of a country. Official reserve
account has the records of foreign official holding and increase reserves of gold and foreign
currencies

Pakistan’s Balance of Payment Performance

REPRESENTATION BY SCHEDULE
1950-51 Favourable Due to KOREAN war
1954-55 Favourable Due to devaluation and restrictions on imports
1955-56 Favourable Due to 20% increase in exports
1958-59 Favourable Bonus Vouchers Scheme And Restrictions on Imports.
1965-66 Unfavourable Deficit due to war against INDIA.
2007-08 Unfavourable Deficit
2008-09 Unfavourable Deficit
2010-11 Unfavourable Deficit

Pakistan’s balance of payment situation has not been satisfactory since independence. The
country with the exception of five years i.e. ( 1950-51, 1954-55, 1955-56, 1958-59 and 1959-60)
has been running a constant deficit in his balance of payment. The deficit in current account is
being met by short and long term loans from the other countries or institutes like IMF.
According to the Economic Survey of Pakistan 2010-11, imports of Pakistan are $ 32.3 billion
and its exports are $ 24 billion. It is showing a deficit of $ 8.3 billion. Above situation is showing
that Pakistan faces a continuous deficit in its balance of payment

It is expected that Pakistan will have to seek assistance from the International Monetary Fund
(IMF) yet again. The last time this happened was in July 2013, when then finance minister Ishaq
Dar defended the IMF plan with the promise that “a better tomorrow dawns only when
requisite pains are borne today”. Unfortunately, it looks like Pakistan must suffer a bit more
before any new dawn breaks.
Why is Pakistan back in trouble with balance of payment? The Pakistan Muslim League-Nawaz
(PMLN) government received a big break early in its tenure when the price of oil fell from
around 100 US dollars a barrel to less than half that amount. Since almost a third of Pakistan’s
imports are based on oil, the decline in oil prices provided the government some significant
breathing room to plan for the future and put its financial house in order. Unfortunately, the
opportunity was squandered as the PMLN government failed to take the steps necessary to put
Pakistan’s balance of payment position in order.
There were three basic issues that needed to be addressed. First, the government should have
taken advantage of low oil prices by building up foreign currency reserves to offset the impact
of future increase in oil prices. A good example to follow is that of Chile, a country that actively
saves foreign currency when copper prices (its main export) rise. Since this was not done, the
subsequent rise in oil prices since July of last year has put predictable pressure on Pakistan’s
balance of payment.

Third, and most importantly, Pakistan’s anemic performance in the export sector is directly
responsible for its perpetual balance of payment concerns. For example, since 1980, exports
from India and Bangladesh have grown at a rate that is more than five times that of the growth
of Pakistan’s exports. Unfortunately, the PMLN government failed to make any improvement in
export performance. In fact, Pakistan’s total exports actually decreased in real terms during the
PMLN tenure.

One reason for Pakistan’s poor export performance was Dar’s strange infatuation with keeping
the rupee at or below the rate of 100 per US dollar — something he openly acknowledged in
December 2013. The rupee exchange rate, like any other price in the economy, is ultimately a
function of demand and supply. Dar’s insistence on keeping an overvalued exchange rate
disproportionately hurt exports.

To make matters worse, the government engaged in an import-led growth strategy by

borrowing from abroad to finance large-scale infrastructure projects — the China-Pakistan
Economic Corridor (CPEC) being the most prominent example. It is well known that high net
borrowing from abroad leads to real exchange rate appreciation which further restricts export
growth. All of these elements have combined to generate the current balance of payment crisis.
The new government that comes to power must address these issues in order to address the
problem of rapid depreciation of the rupee.

REASONS OF DISEQUILIBRIUM
These are the permanent problems of deficit.

A: Limited export capacity

Narrow export Base Pakistan basically is an agricultural country. Its major exports are rice,
cotton, raw wool, leather, fish etc. Our exports, during the last five years, are remaining around
$ 15 billion to $ 20 billion. The reason is that our export base is narrow. It is concentrated in
relatively low value added goods. Value of exports during 2010-11 is 24 billion.

Consumption Oriented Society People of Pakistan are mostly consumption oriented. Due to
rapid rise in population and increased consumption habits, the domestic manufactured goods
are mostly consumed in the country. The exportable surplus is going on decline. Govt. has to
import 4.0 million tones of wheat and heavy amounts of sugar, pulses and tea in 2005-06, being
an agrarian country.

Less Modernization of Machinery Since 1970’s, there have been less modernization, balancing
and replacement of machinery in the private industrial sector. The fall in production and decline
in the quality of products has adversely affected exports.
 Increase in the Sick Industrial Units The number of sick industrial units, mainly due to
nationalization of industries, has borne up. It is on record that the performance of most of the
industries in the public sector is not satisfactory. The decline in production of semi-
manufactured and manufactured goods reduces the exportable surplus and adversely affects
the volume of trade.
Less Production of Value Added Goods The share of industry in the GDP is 25.8 %. The share of
value added goods must increase to earn over many years. The share of value added goods
must increase to earn foreign exchange and turn the trend of adverse balance of payment. The
production of value added goods is at basic stage in Pakistan that leads to adverse BOP.
Devaluation The repeated devaluation of rupee against US dollar has not helped in the increase
of exports. It has made the imported inputs more costly. The demand for our goods in the
international market is elastic. As such, due to devaluation, as tool for boosting, exports are not
effective.
Tough Competition Stiff competition in the foreign market particularly of our value added
goods has reduced the volume of foreign trade in Pakistan. There is availability of higher
standard goods at lower prices in international market. It causes reduction in exports, which
result in deficit in BOP

Anti-dumping Duties Japan, Hong Kong and some other nations imposed antidumping duties
on our cotton yarn, fabric and bed linen. Such types of duties on our exportable goods are also
a big hurdle in the way of our exports.
Technical Barriers Imposition of non-tariff, barriers like child labour, ISO 14000 etc., has
adversely affected our exports for the last years. The advanced countries of the world have
imposed technical barriers such as patents, copyrights, trade-marks and designs etc. on their
imports. Pakistan will have to upgrade the standard of purity and quality to compete for its
products in the international market.
Political Uncertainty The political uncertainties in the industrial units have considerably
affected the efficiency of the industries. The fall in the volume of production, particularly in the
manufacturing value added sector has reduced export earnings. Due to reduction in export
earning, our BOP is unfavourable.
Fall in Terms of Trade
The import unit values are higher than the export unit values for the last over three decades in
Pakistan. A decline in terms of trade causes imbalance in the balance of payment.
TOT = [(Export Price Index ¸ Import Price Index) ´ 100]
TOT = (296.10 ¸ 446.01) ´ 100] = 66.39 indices
Above computation is showing that we lost about 33.61 % of our export earnings in 2005-06.
According to Economic Survey of Pakistan 2010-11, terms of trade are 59.3 indices.

B:Un restricted exports Needs

Import of Capital Goods

Pakistan has to import capital goods for rapid industrialization of the country in order to build
up the economy. The heavy import of machinery has considerable increased the import bill and
has adversely affected balance of payment.
Import Oriented Industry
Some of our industries are based on the imported inputs and raw material e.g., oil and
petroleum etc. Most of industries, which were established for achieving the twin objective of
earning and saving foreign exchange, have been eating away roughly 30 % of aggregate import
bill.
Rise in Oil Prices
The sharp rise in the prices of oil particularly in 70’s and also in the beginning of 1980’s and
1990’s is taking a big amount of the foreign exchange earnings. Our import bill of petroleum
group is increased to $ 8670.4 million in 2007-08, while it was $ 530 million in 1978-79.
Increases in Import Payment for Fertilizer
There is sharp increase in the import payments to the outside world due to increase in prices of
fertilizers, edible oil and petroleum. Our balance of payment shows debit due to high payments.
Defense Needs
We have to purchase modern weapons for our defense at a very high cost from different
countries, which increases burden on our BOP and it becomes adverse. Expenditure on defense
is Rs. 275 billion.

Measures to Correct Adverse BOP

Measures to correct the deficit balance are of three types:
A. EXPORT LED GROWTH
Labour Intensive Industries
Labour intensive industries should be established, because labour is cheaper in Pakistan, these
industries can be set up at lower cost. The products of these industries can be exported.
Manufactured Goods
Instead of exporting primary goods like raw cotton, Pakistan should export manufactured goods
like textiles and garments, leather goods, food products and electrical goods.
Reduction in Export Duties
This step will make our export competitive in the international market. Foreigners will prefer to
import from Pakistan because of low prices.
Quality Products
Many of our goods cannot be exported because of poor quality. Thus, electric fans, cycles,
electric motors, shoes, ball pens, crockery etc. cannot be sold abroad. Pakistan is needed to
improve the quality of its products according to international standard.
Export Marketing
Agencies should be made more active. Pakistan has already done this. There are Export
Promotion Bureau, Export Development Fund and Export Processing Zones etc. All these are
playing their effective role to increase export and to correct the BOP.

Immoral Practices
Many Pakistanis have brought bad name to our trade because they export commodities of
inferior quality than specified in agreements. So, all this should be restricted.
Pricing of Goods
It is necessary for increasing exports that goods should be produced under optimal conditions
and offered at competitive prices in international market.
Packing
High quality packing is essential for promoting exports. If packing is not attractive and durable,
it will not capture foreign market.
Joint Venture
Establishing industries with joint venture of foreign investors can also push up the export. The
products of these industries can be sold in the foreign market.

B. REDUCTION IN IMPORTS
Import of Only Essential Items
Only essential items should be imported which are needed for our industrial production. Import
of luxuries should be banned. People should be educated to come out from the complex of
foreign goods.
Exchange Control
Exchange control is also an important step to minimize the imports. Exchange control should be
followed, so that there is no wastage of foreign exchange to import of un-necessary and
luxuries.
Substitutes for Imported Items
Import substitutes should be manufactured in the country. If home production of fertilizer,
paper, steel, edible oil and electrical goods are increased, there will be less need for such
imports.
C. MISCELLANEOUS
Decrease in Consumption
Taxes should be imposed to reduce the consumption of many items. Rich people in our country
are spending freely on unnecessary imported consumer items. So, foreign exchange reserves
are wasted.
Control of Smuggling
Bara markets should be eliminated. After atomic explosion, the Govt. is taking strict measures
to eliminate markets of smuggled goods.
Population Control
Many of our problems are arising due to fast increase in population. Sincere efforts should be
made to decrease growth rate of population. People should be educated in this regard.
Conclusion:
Achievement of surplus in balance of payment is difficult but not impossible. It can
achieve through installing import substitution and export promoting industries. Government
should control the forex and check the import of luxuries