International Economics Assignment

Submitted to: Ma`am Mehtab Submitted by: Anum Farooq Roll no: 363 Major : Economics BS 4 Semester 8th

Topic : Balance of payment in case of Pakistan

Lahore College for Women University

BALANCE OF PAYMENT IN CASE OF PAKISTAN

Balance of payments is a summary statement of all the economic transactions between the residents of one nation and the rest of the world during the course of one year. It presents a classified record of all receipts on account of goods exported, services rendered and capital received by residents and payments made by theme on accounts of good imported and services received from the capital transferred to non-residents or foreigners. The items which lead to an inflow of foreign earnings are placed on credit side of the balance sheet, where as the items which give rise to an outflow of foreign currency are placed on the debt side. Equilibrium in balance of payment: Balance of payments equilibrium occurs when induced balance of payments transactions--those engineered by the government to influence the nominal exchange rate---are zero. This implies that autonomous receipts from exports and the sale of securities abroad equal autonomous payments for imports and the purchase of securities from foreign residents. Disequilibrium in balance of payment: Though the credit and debit are written balanced in the balance of payment account, it may not remain balanced always. Very often, debit exceeds credit or the credit exceeds debit causing an imbalance in the balance of payment account. Such an imbalance is called the disequilibrium. Disequilibrium may take place either in the form of deficit or in the form of surplus. Disequilibrium of Deficit arises when our receipts from the foreigners fall below our payment to foreigners. It arises when the effective demand for foreign exchange of the country exceeds its supply at a given rate of exchange. This is called an 'unfavourable balance'. Disequilibrium of Surplus arises when the receipts of the country exceed its payments. Such a situation arises when the effective demand for foreign exchange is less than its supply. Such a surplus disequilibrium is termed as 'favourable balance'. Causes of Disequilibrium in Balance of Payment: Following are the major causes of disequilibrium in balance of payment in developing countries like Pakistan.

1.Export of Primary or Semi Manufactured goods: Developing countries like Pakistan are exporting primary or semi manufactured goods like cotton and rice. These commodities do not get high prices in the international market. Near about 40% of total earning of foreign exchange is had by the export of primary or semi-manufactured goods. 2. Import of Capital Goods: Developing countries like Pakistan are importing capital goods to industrialise the economy. Due to this reason balance of payment remains unfavourable. 3. Import Oriented Industries: The imports of industrial raw material in the aggregate import are placed at 50%. 4. Consumption Oriented Society: Developing countries are mostly consumption oriented. Due to this reason most of the goods which are produced within country are consumed locally. The exportable surplus is on the decline. 5. Deterioration in Terms of Trade: In developing counties like Pakistan the import unit values are higher than export unit values. So a decline in terms of trade causes imbalance in the balance of payments. 6. Unfavourable altitude of Developed Countries: Due to unfavourable altitude of developed countries our balance of payment is unfavourable. For example the developed countries like U.S.A. and U.K. have put many restrictions on imports from Pakistan. They have fixed quotas against the cloth of Pakistan. 7. Inflation: Due to inflation in developing countries like Pakistan the price of exportable goods are very high. Their goods face difficulties to compete in international market and balance of payment remain unfavourable. 8. Political Uncertainty: Developing countries like Pakistan are facing political uncertainty which is the main cause of low production as well as balance of payment remain unfavourable. 9. Devaluation: Devaluation is also cause which increases the deficit in the balance of payment. In 1975 Pakistan devalue her currency and in 1982 Pakistan delink her currency with dollar which also increased the deficit in the balance of payment. 10. Import of Oil and Fertilizer: Import of oil and fertilizer is also cause of deficit in the balance of payment of Pakistan. 11. Developing Economy: Developing countries like Pakistan is undertaking huge programmes of development of industry, agriculture, transport, education, communication,

irrigation and electricity. For this purpose various kinds of raw material and machinery are needed. So balance of payment remains unfavourable. 12. Repayment of Debt and Interest: Developing countries like Pakistan are paying the debt and interest of the debt which they borrow for development purpose. It is a great burden which affects the balance of payment badly. 13. Huge Import of Invisible Goods: Due to import of invisible goods the balance of payment remains unfavourable of developing countries like Pakistan. 14. Variations in Trade: There may be temporary disequilibrium caused by random variations in trade due to seasonal fluctuations, the effects of weather on agriculture production etc. Deficits in balance of payment due to variations in trade are expected to correct with in short time. 15. Fundamental Disequilibrium: They may arise due to fundamental changes in the economic conditions of a country. They may be due to changes in consumer tastes with in the country or abroad there by affecting the countrys import or export. Due to this reasonbalance of payment remains unfavourable. 16. Technological Changes in Method of Production: Due to this reason in the domestic industries or in the industries of the other countries may affect the countrys ability to compete in the home or foreign market. This may be due to changes in costs and prices and the quality of products following technological improvement. 17. Changes in Countrys National Income: If the national income of a country increases it will lead to an increase in imports whereby creating a deficit in its balance of payment, other things remaining the same. Measures To Correct Disequilibrium in Balance of Payment: The disequilibrium of balance of payments can be corrected in three ways. A: The foreign earning should be increased by export led growth. B: The imports should be curtailed to essential items only. C: The expenditure on invisible imports should be minimized. We now briefly describe the above three methods.

(A) Export Led Growth: Export plays an important role in the growth of the economy. It is regarded as key factor in the economic development. As regards the developing countries like Pakistan, they have rich manpower and real resources. If they are properly exploited and utilized, there can be significant improvement in exports and foreign exchange earnings. We suggest the following measures to be adopted for increasing exports and alleviating the balance of payments problems. (1) Promotion of Labour Intensive Industries: Promotion of labour intensive industries should be established because in such countries labour is cheaper. The cheap labour can give a comparative advantage in the production and export of commodities. The export earnings, therefore can increase and help in restring equilibrium in balance of payments problem. (2) Diversification of exports: The developing countries like Pakistan have been showing heavy concentration on a few primary commodities. If there is a recession in international market for cotton and rice of Nature is not kind, the production declines and exports are greatly reduced and have a damaging effect on the balance of payments. They should therefore diversify their exports and produce value added goods for gaining competitive strength in the international market. (3) Development of Industries having low capital output ratio: Developing countries like Pakistan with low foreign exchange earning cannot afford to import heavy machinery. If they like Korea, Taiwan, Hong Kong, Singapore, take up lines of production having a low capital output ratio it can lead to fast growing export. (4) Decrease in Consumption: Inspite of rapid rise in prices there is a greater increase in national consumption of developing countries like Pakistan. The higher consumption of locally manufactured goods is reducing the exportable surplus and consequently the foreign earning to them. The people should be motivated to adopt simple living and austerity for bridging the resource gap. (5) Restoration of Sick Industries: The sick industries in the nationalized public sector should be restored and handed over the private sector. The private sector has the capacity to reactivate the dying industrial units and increase the production for use at home. It can thus increase exports to earn the much needed foreign exchange. (6) Reduction in export duties: Reduction in export duties, publicity of locally manufactured goods in the foreign markets, adequate provision of credit to the private sector for

development of industries etc earn greatly help in increasing export earnings and relieving the pressure on balance of payments. (7) High quality goods: In order to capture foreign markets, it is necessary that high quality goods at minimum cost should be produced. (8) Pricing of goods: For increasing exports, it is necessary that goods should produced under optimal conditions and offered a competitive price in international market. (9) Packing: For promoting exports, high quality packing is essential. If packing is not attractive and durable it will not capture foreign markets. (10) Creation of export agency: For break through in exports export agencies should be created in private sector. (11) Joint Venture: The exports can also be pushed up by establishing industries with joint ventures of foreign investors. The producers of these industries can be sold in the foreign markets and the country can earn sizeable foreign exchange. (B) Reduction in Imports: In order to correct disequilibrium in balance of payment, the governments of developing countries like Pakistan should reduce the import of consumer goods. Similarly raw material which can be produced in the country at a cheaper cost should not be imported. The decline in imports of consumer goods and industrial raw material can greatly reduce the deficit gap. (C) Reduction in Invisible Imports: The payments on invisible imports like shipping, insurance, banking, services, payments of technocrat working in various establishments, expenses on diplomats etc are on increase in developing countries like Pakistan. These payments should be curtailed down.

TREND, VOLUME AND VALUE OF FOREIGNTRADE SINCE 1947

FIRST PHASE (1948 TO 1950) The special features of this phase were, Devaluation of pound sterling in 1948, Decrease in external value of Indian rupee a major importer of Pakistans jute, Non-devaluation of Pakistani rupee, Decrease in volume of trade (open general license scheme) Korean war

Pakistan just after the independence faced problem of shortage of essential commodities. in 1948, government of Pakistan lifted ban on imports be on imports which resulted in increase in the volume of imports. In September, 1949, British government devalued her currency by 30%to correct her balance of payments position. in response to this devaluation , common wealth member countries including India devalued their currency but Pakistani did not devalues its currency because of greater demand of exports .India who was the bigger importer of Pakistani jute and cotton ceased to import and also restricted exports to Pakistan. Pakistan had to face a difficult situation becausePakistans60% foreign trade was with India, however, Pakistan successfully faced this challenge and efforts were made to divert its trade with other countries of the world. it reduced dependence on India. In mid-1950, Korean War started. The demand for our exports increased sharply, Pakistan earned a lot of foreign exchange due to increased quantity of exports of jute and cotton SECOND PHASE (1951 TO 1955) The special features of this phase were: Import policy was liberalized. End of Korean war, Reduction of imports by advanced countries, Abolished open general license(OGL)As a result Korean War, the industrial developed countries stated increasing the imports of raw material; the import policy was liberalized through OGL. India also started importing jute from Pakistan. This made balance of payment position favorable. The Korean War soon ends export prices of jute and cotton feel sharply. The industrially developed countries which had stockpiled raw material for years reduced imports. Therefore, balance of payments position again became unfavourable government of Pakistan again adopted the import control policy and abolished OGL. Under stringent conditions all imports ere made licensable from 1952. THIRD PHASE (1955 TO 1960) Special features of this phase were. Devaluation of currency, Import of food grain, New export promotion schemes. In 1950spakistan started the policy o industrialization and import substitution. Besides this due to bad weather conditions and poor exports Pakistan was forced to devalue its currency to boost exports. Due to industrial development, home industry started consuming jute and cotton which decreased the quantity of exportable surplus. To increase exports earnings various schemes were started. In 1958 martial law government initiated new schemes for export promotion; Export promotion schemes Industrial development Indo-pak war Low exchange import

FOURTH PHASE (1960-1965) Period from 1960 to 1965 can be treated as a period of higher rate of economic development and export incentives. During this period foreign trade expanded bit volume and value of imports was greater than exports. This increased trade deficit yet industrial performance remained satisfactory. Martial law government took many steps to boost exports. Export promotion council was established and export credit guarantee scheme was stared. In this period composition of exports changed from export of agriculture raw material to semi manufactured goods and manufactured goods. Pakistan trade relations with east European countries are improved FIFTH PHASE (1965-1970); THE PERIOD FROM 1965 TO 1970 was a period of disaster for Pakistan .In September 1965 indopak war started and Pakistan had to spend huge amount of its foreign exchange on import of defence armaments. During 1966-1967, there was a serious food shortage and Pakistan had to import wheat. The inflow of foreign aid remained below the target. The export targets could not be achieved. The political instability from 1968-1970 also effected trade and balance of payments remained unfavourable . SIXTH PHASE (1971-1977) East Pakistan separated from West Pakistan in 1977.import structure was distributed. There was an export shortage. however, efforts were made to accelerated exports and these efforts proved fruitful. Pakistan faced a serious shortage of foreign exchange, to overcome this problem in 1972, Pakistan devalued its currency by 131%, multiple exchange rate policy and export bonus scheme were abolished. The exports fell short of target due to the following reasons, Nationalization of industries, Monetary and fiscal changes, Floods in 1973-1974, Unorganized efforts to increase export. SEVENTH PHASE (1978-1983): The period from 1978 to 1983 is treated as a period of economic prosperity and stability. There was an increase in exports. Exports grew at a reasonable rate, imports along with exports showed an upward trend. In January, 1981, one rupee note was declined from dollar which accelerated the exports. Although it was not devaluation but our currency demonstrated a decline in external value. In 1979.afghan refugees entered in Pakistan which increased burden on imports and decreased exports.

EIGTHTH PHASE (1983 TO 1991): In this period wheat, sugar and food grain shortage appeared foreign remittances stared declining and foreign debt washout up to 16 billion dollars. During the period of 1985-1986, exports increased than imports but at the same time foreign remittances started declining due to coming back of Pakistani workers after completion of projects and development programs and decrease in oil prices. Due to decrease in oil prices, Pakistan import bill decreased by Rs.6 billion. Foreign debt increased from 12 billion dollars in1984 to 16 billion dollars in 1991. NINTH PHASE (1992 TO 2009): Many political changes appeared in the country. There was a fall of government by Nawaz Sharif, then Benzir Bhutto and then again NawazSharif government in 1999 and gen. Musharaf took over the government. Total exports which were 16 billion dollars reached in2008-2009.percentage share of exports of primary commodities, 11%,manufactured goods 61.4% .total imports declined to 26.7 billion dollars in 2008-2009.

CAUSES OF ADVERSE BALANCE OF PAYMENTS YEAR TRADE REASONS SURPLUS 1947-48 Rs.125 M Exports of newly Pakistan were high 1950-51 Rs.176 M KOREAN WAR, exports of cotton &jute were high 1972-73 Rs.153 M In1972, devaluation of currency by 131% of Pakistani rupee. 1. FISCAL POLICES: Pakistans fiscal policy has been a serious obstacle to the expansion of its exports. The import duties on the raw material required for the production of certain goods which have an export potential are so high that the production costs make the goods uncompetitive in the world market. 2. EXPORT OF PRIMARY COMMODITIES The main factor for unsatisfactory export performance is stated to be the adverse trend in the terms of trade. but this is the result of heavy dependence of the countrys export earnings on primary commodities like cotton and rice and semi-manufactured goods, which are subject to frequent price fluctuations in the world market.

3. INFLATION Inflationary conditions are a serious obstacle to the promotion of exports. Inflation results in a rise in the domestic cost of production so that the goods produced cannot compte in the world market.BOP were also affected by the impact of inflationary pressures. 4. CONSUMTION ORIENTED SOCIETY Pakistanis are mostly consumption oriented. Due to rapid rise in population and increased consumption habits, the manufactured goods are mostly consumed in the country, so, a smaller portion is left for exports. 5. TRADE BARRIERS OF DEVELOPED COUNTRIES The trade barriers raised by developed countries against the import of manufactures from the developing countries is one of the important factor preventing greater production and export by some industries in Pakistan, particularly the cotton textile industry. 6. IMPORT SUSTITUTION POLICY OF PAKISTAN The emphasis of Pakistans industrial policy has been more substitution than on exports expansion .the position of domestic industries results in higher prices for the consumer. In Pakistan, industries have a sheltered domestic market tend to become inefficient due to absence of foreign competition 7. SLUGGISH GROWTH OF PRODUCTION Pakistans major exports comprise of agriculture goods i.e. cotton, its products and rice. Pakistan has a large area of cultivation but it is not utilized properly. Mostly the cultivatable area is affected through poor drainage system. Another reason is climate conditions .if the whether conditions are unfavorable, the production of these commodities goes down and the production of the commodities is affected heavily and causes reduction in exports. 8. OBSOLETED TECHNIQUES OF PRODUCTION The industrial sector as well as agriculture sector in our country are still operating on the machinery manufactured before 1980.especiaaly in the public sector modernization, balancing and replacement of machinery is out of question since 1972 which results a fall in production and the quality of products, also remains low and it is not possible to increase exports and to compete even with developing countries. 9. UNBALANCED PRICES The frequent changes in the fiscal and monetary polices of Pakistan in the past years had disturbed the level of investment, the volume of imports and exports.

PROCEDURES TO CORRECT BALANCE OF PAYMENTS Export of manufactured goods Pakistan should export manufactured goods (leather goods, electrical goods etc.) instead of primary goods. Quality products Many of our goods can not be exported because of poor quality. Quality products should be manufactured for increasing the exports in international market. Import of fundamental items: Only essential items should be imported which are needed for our industrial production. Import of luxurious should be banned. Import Alternative Import substitutes should be manufactured in the country to save the foreign exchange on imports. Terms of trade .Terms of trade of Pakistan are unfavorable which increasing deficit in our balance of payments is so there is a need to improve terms for trade by exporting finished goods instead of raw material and primary goods. Special Schemes In order to improve balance of payment, government should introduce special schemes for the exporter and importer. Through these schemes exporters should be encouraged and importers should be asked to minimize imports. Self-Sufficiency: Pakistans balance of payments is now worsening due to repayment of debt and debt servicing .to avoid further deficit we must follow the self reliance policy. Exploring export markets: More emphasis should be laid on export survey and export market entry. it is paramount importance that our exporters should know more about operating in a foreign market. it must also be our export policy to make preparations for organizing our efforts to secure more export orders from abroad. There is need to survey foreign markets, opening of display centers and information offices abroad and exploring the foreign markets by our manufactures for sale of Pakistani goods. Reducing the balance of payments deficit depends on our rapid industrial production and the quality of our products. We need to fully utilize the idle capacity of our industries. We can import advanced technology for increasing home production. The tax element in the cost of production of export commodities needed to be eliminated except where it was desired to tax export of specified commodities.