Current account + FDI Situation:

The current account deficit peaked at almost $14 billion, due primarily to the extremely high oil
price in 2007-08.
After that, it showed a sharply declining trend up to 2015-16. After 2015-16, the exponential
growth in the deficit is mainly attributable to the significant rise in the real effective exchange
rate, implying that the rupee was kept substantially overvalued.
The PML(N) government chose this strategy to keep the inflation rate low, especially before the
elections. However, this led to a 30 per cent jump in imports from 2015-16 to 2017-18.
The bottom line regarding the level and change of foreign exchange reserves reflects the size of
the current account deficit and net inflows into the financial account.
The level of reserves shows a clear cyclical pattern. From 2007-08 to 2010-11, they rose from
$9.7 billion to $15.6 billion. They then fell to $7.2 billion in 2012-13. Between 2012-13 and
2015-16, they rose rapidly once again to reach the peak of $19.4 billion in 2015-16 and then
declined sharply to $11.4 billion just before the exit of the PML(N) government. This was
followed by another cycle, and the year 2021-22 closed with relatively low foreign exchange
reserves of $9.8 billion.
SBP Policies for Stabilizing the Balance of Payments:
At the end of 2017-18, the low reserves position prompted the SBP to pursue an aggressive
monetary policy in 2018 - 19 to reduce the current account deficit, generate a surplus in the
balance of payments, and build up reserves again.
Table 2.2 shows the monthly movement in the two monetary policy instruments, namely
the policy and exchange rates, in 2018-19. The cumulative magnitude of the moves
was enormous. They led to a depreciation in the rupee by almost 31 per cent and a rise in the
SBP policy rate by as much as 575 basis points.
The fundamental question is, what impact did these moves have on the balance of payments in
2018-19? Table 2.3 compares 2018-19 figures with 2017-18.

The outcome was not as positive as was hoped. Despite the big moves, imports fell by less than 7
per cent. Overall, the trade balance improved by less than 11 per cent because exports declined
despite the much better exchange rate offered to exporters.
The big surprise was the significant worsening of inflows into the financial account. The low
reserves at the start of 2018-19, plus the considerable monetary policy moves, heightened
negative perceptions about Pakistan.
There was a significant outflow of equity funds from Pakistan, and foreign direct investment fell
by 50 per cent. The net inflow into the government account was also at half the level of 2017-18.
The only positive development was the large bilateral deposits into the SBP from friendly
countries like China, Saudi Arabia, and the UAE, totalling $5.5 billion.
However, the overall balance of payments remained in deficit in 2018-19, and reserves fell
further to the critically low level of $7.3 billion, enough to provide import cover for only 1.2
months.
Pakistan was left with no option but to go to the IMF. In retrospect, the delay of over a year in
going to the IMF for a three-year extended fund facility can be considered a mistake. If there had
been an umbrella of a Fund program in 2018-19, the flows into the financial account would have
been more significant.
Also, the almost draconian increase in the policy rate and significant depreciation of the rupee
may not have been necessary.
The Continuing Search for Financial Stability:
Pakistan entered a three-year Extended Fund Facility with the IMF in July 2019 of $6 billion.
The macroeconomic projections made at that time in the Program for the period 2019-20 to
2021-22 are given in Table 2.4

Therefore, the Program projected a gradual acceleration in the GDP growth rate and a decline in
the inflation rate. A 50 per cent reduction was targeted for the current account deficit in 2019-20,
with further reductions in the next two years. Consequently, the foreign exchange reserves were
expected to rise from $7.3 billion in 2018-19 to $11.6 billion in 2019-20 and reach $19.3 billion
by the end of 2021-22. The SBP was expected to pursue an aggressive monetary policy with a
market-determined exchange rate and use the policy rate to limit aggregate demand. The focus
was on achieving sustained financial stability of the economy.
The economic environment in Pakistan was fundamentally altered after the COVID-19 pandemic
hit the country in March 2020. There was a significant slowdown in economic activity. The
world economy went into deep recession, and international commodity prices plummeted.
Pakistan’s imports became cheaper because of this fall in global prices, as shown in Figure 2.1

The overall unit value index of imports in US$ fell by as much as 28.8 percent in 2019-20. The
balance of payments position improved substantially. Imports fell by 16 percent in 2019-20, and
the current account deficit declined by 68 percent, from $13.4 billion in 2018-19 to $4.4 billion
in 2019-20. This was significantly better than the IMF Program target of $6.7 billion. Reserves
also rose by $4.6 billion, close to the Program target. However, the inflow into the financial
account was smaller than in 2018-19. This was due to the flight of $3 billion of ‘hot money’,
which had come into Pakistan when interest rates were at their peak, with the policy rate at 13.25
percent. Following COVID-19, the precipitous drop-in interest rates led to the exit of this money.
The IMF program was suspended because of the economic dislocation caused by COVID-19. In
June 2020, the IMF gave Pakistan a particular loan of $1.4 billion under the Rapid Finance
Facility.
The program was restored in late 2021; the sixth review was completed in February 2022.
Pakistan also received a special SDR allocation of $2.8 billion in August 2021.

Monetary, Exchange Rate and Financial Sector Policies:

As shown in Chart 5.3, there are five crucial action/ reform areas.
The government has committed to maintaining a market-determined exchange rate and a flexible
policy for setting the SBP policy rate in light of economic conditions.
Further, there is agreement on phasing out subsidized SBP refinancing schemes, eliminating
exchange and import restrictions, and effectively implementing the AML/CFT Framework.

Dr. Hafiz Pasha,

Professor Emeritus, Department of Economics – School of Business,
Beaconhouse National University, Lahore.
Tarogill Campus, 13 KM off Raiwind Road, Lahore, Pakistan
Former Finance Minister and UN Assistant Secretary General
Email: [email protected]