DAWN - Business; 12 January, 1998

Foreign capital: a gain or drain?

By Dr Abdul Karim

Balance of payments deficit is a permanent feature of Pakistan's economy but the situation has become difficult in recent years. Of late, this has become all the more acute, so much so that there is always a lurking threat of default. In fact, according to the latest State Bank Annual Report for 1996- 97.

"A sharp fall in foreign exchange reserves in the first quarter (July-Sept. 1996) posed a threat of default in the country's external liabilities."

Hence frantic efforts by the government to acquire foreign exchange from any source, in any form, and at any cost and terms. This includes borrowing from international lending agencies with stiff conditionalities, short-term commercial borrowing at prohibitive rates, and incentives to foreign investment.

Pakistan has surpassed almost all developing countries in offering incentives by way of the extent of foreign ownership and the fields open to the investment. Even family silver and basic infrastructure, real as well as financial, are being offered for sale for foreign exchange.

Foreign capital, unless it is in the form of grant, comes with a cost which will be regular payment of interest and repayment of principal of loans? according to the agreed scheduled, and recurring payment of profit and repatriation of principal, if and when the investment is liquidated.

As such, foreign capital is beneficial only if it is put to uses which enhance the productive capacity of the recipient and hence the ability to service it.

Most of the current borrowing has been in the nature of a "fire fighting" operation to avert default and to bolster the foreign exchange reserves to a level required, as a mandate, to have access to funding by international lending agencies and other sources.

Pakistan has been living on borrowed reserves for quite some time. The problem of default and an international commitment apart, in narrow financial terms, this is a losing proposition, as the deployment of the reserves will get much less than what has to be paid on them. This can be put up with, if this can help unlock other external resources at easy terms. This is what has happened in case of Pakistan.

The availability of IMF credit was contingent on, among many other things, on the level of foreign exchange reserves. The seal of approval of the IMF was a pre-requisite for the flow of funds from many other sources. This raises the overall question whether foreign capital has been so far beneficial for Pakistan and what are the future prospects.

In the early fifties when official foreign aid started coming in a big way, it was hoped and earnestly argued that the country will develop soon to the level that it would become selfsufficient.

However, the marginal rate of domestic saving assumed then never materialized, with the result that the country has become permanently dependent on external resources.

The burden was not heavy so long as concessional official assistance was available. But this has changed dramatically since the end of the cold war and the introduction of the New World Order.

Consortium commitments make head lines in the country but in actual fact they now hardly service themselves. Net transfer- disbursements minus repayment of principal and interest due on long-term external government debt, had dropped from 70 per cent in 1970-71 to 30 per cent in 1980-81 and was 36 per cent in 1990- 91. By 1995-96, this was down to 16 per cent.

According to the Economic Survey, 1996-97, issued before the national Budget, it was expected to be only 2 per cent during 1996-97. The figures published recently in the Statistical Supplement to the Survey, which are still provisional, put the net transfer as negative, meaning an outflow, of $32 million or by 0.02 per cent. This is an important milestone so far as official external resources are concerned.

It is significant that a good part of the above aid was used not for development but for consumption. Of the total loans and grants disbursed upto end-June 1997, non-project aid claimed 36 per cent, of which food-aid alone was 13 per cent, relief 4.2 per cent and balance of payments support 4.3 per cent.

The government had a preference for this kind of aid, as it helped the budget, being quick disbursing and Rupee generating. The use of project aid has been quite slow because of project preparation and the need for matching Rupee resources.

As a result, on that date project aid worth $10 billion, or 25 per cent of the amount committed, was unutilized. External borrowing for financing import of petrol? edible oil and wheat has become a regular practice.

So far medium and short-term external debt of the government was not made public. The latest State Bank Annual Report provides this valuable information. The figures, however, also include unguaranteed private credits but does not give the break up into public and private liabilities.

According to the Report, the outstanding medium and short-term debt doubled from $3 billion as of end-June 1993 to $6 billion on the same date in 1997. Total outstanding external debt, long, medium and short-term thus stood at $29.6 billion. Its servicing during 1996-97 was of the order of $5 billion, of which principal repayment was $4 billion.

Debt servicing during the year was equal to 38 per cent of total foreign exchange earnings and 61.8 per cent of export earnings. These are only formal loans. There are other forms of external liabilities such as deposits and swap arrangements.

That information is not yet separately published but balance of payments data can give an idea bout the magnitude of these flows.

It is against the setting of practical drying up of confessional official aid and the situation created by the New World economic Order that Pakistan had to turn to non-official sources of capital and this was facilitated by reform of the financial sector beginning in 1990-91.

According to the balance of payments data, Capital liabilities (net) of Pakistan increased by $9.1 billion during 1986-91 and by $15.0 billion during 1991-96. an increase of 66 per cent over the two periods. While addition to public liabilities during the five-year period ending June 1991 and thereafter remained around $7 billion, there was a sharp fourfold increase in private liabilities from $2 billion to $8 billion. Provisional figures place the total increase during 1995-97 at $2.9 billion, of which the public sector claimed $1.5 billion.

The flow of private foreign capital can be either in the form of loans or investment. The latter consists of portfolio and direct investment.

The former brings in cash and basically changes the ownership from local to foreign investors and can easily be reversed. On the other hand, direct investment not only brings in capital but also technology and management. It takes time to materialize and to be liquidated.

There has been a big increase under both heads. Again taking the five-year periods before and after June 1991, while portfolio investment (net) jumped from $409 million to $2.3 billion, the largest amount invested in a year was $1.3 billion. At the same time, direct investment increased from $941 million to $1.5 billion.

Thus more investment came under portfolio investment than direct investment in the five-year period ending June 1996. Of the other private capital on private account, long-term increased from $809 million to $2.3 billion and shortterm from $233 million to $1.3 billion.

In short, after 1990-991 there has been a sharp increase in the use of foreign capital, most of it obtained under the stress of circumstances-the pressure on reserves.

The price the country has to pay by way of remittances on account of investment income, that is interest on loans and profit on investment, beside the capital repayment of principal, is increasing at a rapid pace and the current account of the balance of payments is reflecting that impact.

Net payments on account of investment income, which were only $640 million in 1985-86, increased to $1.2 billion in 199091 and to $almost $2.0 billion in 1995-96. For 1996-97, they have been provisionally estimated at $2.2 billion. They have thus doubled since 1990-91 and were equal to 65 per cent of the trade deficit in 1996-97 as compared with 47 per cent in 1990- 91 and only 21 per cent in 1985-86. In terms of export earnings, the ratios were 22 per cent in 1985-86, 20 per cent in 1990-91, 23.5 per cent in 199596 and 27 per cent in 1996-97.

They now account for over half of the current account deficit. Under this head. payments on account of official external debt (excluding IMP) increased from $360 million in 1985-86 to $611 million in 1990-91 to $949 million in 1995-96 and to $909 million in 1996- 97.

Payments to IMF in 1996-97 were $47 million as against $63 million in 1990-91 and $122 million in 1985-86.

Payments on account of "others" representing interest on private loans and profit on foreign investment rose from $158 million in 1985-86 to $486 million in 1990-91, to $956 million in 1995-96 and to $1.2 billion in 1996-97.

Workers remittances from abroad have been a very big support to the balance of payments. A good part of the trade deficit used to be met by this source with the result that the current account deficit was much smaller than the trade deficit.

Thanks to the remittances, at their height and when payments on investment income were only $420 million, the current account deficit was as low as only 17 per cent of the trade deficit in 1982-83.

With a decline in the remittances and increase in other invisible payments, particularly payment on account of investment income, the ratio tended to increase. By 1985-86 it was 41 per cent and had more than doubled to 87 per cent in 1990-91.

This further rose to 124 per cent in 1995-96 and 126 per cent in 1996-97. It is thus now far in excess of the trade deficit. In relation to GDP, the ratio of current account deficit has risen from 3.9 per cent in 1985-86 to 4.8 per cent in 1990-91, to 7.1 per cent in 1995-96 and provisionally placed at 6.5 per cent for 1996-97.

The impact of increased payments on account of investment income is not confined to the balance of payments alone but affects the economy as a whole through Net Factor Income from Abroad, a component of GNP.

This has been reversed from a net inflow to a net outflow with far reaching implications for economic management. In plain terms, so long as the workers remittances were more than the payments on account of investment income, this supplemented GDP making GNP higher than GDP.

At the height of workers remittances, when they were quite close to total exports, Net Factor Income from Abroad added as much as 12 per cent to GDP. It was 2.6 per cent in 1990-91.

Since then this has not only been wiped out but turned negative signifying an outflow of resources from Pakistan, making GNP smaller than GDP. For the first time, in 1995-96 the figure turned negative by Rs 7 billion or 0.4 per cent of GDP (FC). For 1996-97, the Federal Bureau of Statistics has estimated this as a negative figure of Rs 25 billion, or 1.1 per cent of the GDP, while the Planning Commission places it higher at Rs 29 billion.

The result is that whereas real GDP (FC) shows a small improvement of 0.3 per cent in per capita real income, real GNP (FC) for the first time signifies a small decline of 0.4 per cent during 1996-97.

The reversal in Net Factor Income from Abroad is a permanent shift of rapidly growing nature and has far reaching policy implications. GDP growth has been the basic policy target.

So long as GNP was larger than GDP, due to Net Factor Income from Abroad, economic mangers had a leeway to cover any deficiency to affect the situation on ground. Now with a GNP lower than GDP, the situation may be just the reverse.

A higher GDP will be required to meet the net drain of Factor Income Payments from Pakistan. The traditional and so far ideal target of 6 per cent growth rate of GDP may not be enough even to sustain the present low per capita income. For realistic policies the focus should, therefore, shift from GDP to GNP.

In sum, as Pakistan has not been able to make prudent use of external resources for productive investment, its ability to service external liability has not increased commensurately. In consequence, not only the balance of payments is under increasing pressure but also there has emerged a serious drain on the national economy as a whole.

The government is engaged in "saving the day" and, in the process, is piling up more external national liabilities, though of a some what different in nature.

The real solution lies in stepping up domestic production and saving, which is abysmally low. Improvement in the latter cannot be imagined without radically changing the present consumption- oriented life style, especially among the affluent who set the tone for other sections of the society. What is urgently needed is a sincere campaign of "Austerity for Survival" beginning with the public sector.