Trade with China has never been a simple business for any country. The scale of Chinese investment and production, and the unmatched efficiency of its labour, make it the most formidable competitor in the global market.

Few countries have managed to run a trade surplus with China, whether or not they have a Free Trade Agreement (FTA), and Pakistan is no exception.

Take a look: One-way street: CPEC more about expanding China's growth than benefit for Pakistan

However, the countries that have been able to negotiate a better economic deal on trade and investment have integrated their economies into the global value chains with Chinese investments and transfer of technology.

There has been a perception that Pakistan’s trade deficit with China is due primarily to the tariff concessions that Pakistan extended in China-Pakistan Free Trade Agreement (CPFTA) which both the countries signed in 2006 and became operational in 2007; that it caused injury to the local industry; that Pakistan doesn’t have substantial exportable surplus to benefit from any FTA with China; and that any extension or expansion of CPFTA would lead to further harm to the industry and the economy so Pakistan is better off with the status quo than a new trade agreement. In small part this perception is correct, but it is largely wrong. It smacks of a defeatist approach.

The exporters’ community does not fully share this vision. They want an expansion and deepening of the CPFTA to enhance their access to a huge market of 1.42 billion people, whose purchasing power and demand for imported goods is growing relentlessly. With limited options for Pakistan to benefit from regional trade, the main driver of expansion in trade and growth for most other countries, closing the doors on trade with China would restrict the chances of expansion in trade and economic growth.

Walking the fine line between these two arguments — protecting local industry versus growing trade and growth through bilaterally negotiated trade deals — is a complicated job. Let’s consider the facts before looking at the arguments.

When the CPFTA was signed in 2006, it was the first one for Pakistan and even for China. Both the countries agreed only on 35 per cent of total tariff lines to be liberalised. It can be argued that some of the tariff lines liberalised by Pakistan (such as cell phones) should have been protected (although most of the cell phones are smuggled into the country, FTA notwithstanding).

Similarly, it can also be said that many of the potential lines of Pakistan’s export potential (mainly in textiles) were kept out of the zero-duty list. However, both the parties agreed that after five years (ie in 2012), they will enter Phase II of CPFTA, liberalising 90pc of total tariff lines. The first phase agreement was also weak on safeguards for local industry and balance of payments provisions.

COMMENT, BY INVITATION: From time to time, Dawn will invite somebody with an important voice in an area where the economy or the business environment is facing large challenges and opportunities. We kick off with Secretary Commerce Younus Dagha, on growing trade relations with China as Pakistan moves deeper into the CPEC timeline.

Despite its shortcomings, CPFTA went well for both the countries with China’s exports to Pakistan increasing by 189pc to $6.6bn in 2012-13 (from $3.5bn in 2006-07) and Pakistan’s exports to China increasing much higher by 433pc to $2.6bn in 2012-13 (from $0.6bn in 2006-07).

Subsequently, China signed FTAs with other trading partners allowing them much higher concessions on tariff lines of Pakistan’s interest. As a result, Pakistan’s exports to China started falling after 2012-13 which by 2016-17 had fallen by 42pc to $1.5bn.

Negotiations for CPFTA started in 2011, remained inconclusive for seven rounds till 2017 when Pakistan offered to raise the level of negotiations to Secretary Commerce from Pakistan and Vice Minister from China.

The last three rounds ironed out a lot of issues such as reducing the level of liberalisation from 90pc (anticipated in 2006 for Phase II) to 75pc, thereby increasing the room of protection for 25pc tariff lines which more than sufficiently cover not only our existing industry but also cover the prospects for future industrial expansion.

It has also been agreed to include robust conditions for suspension of concessions in case of injury to local industry or balance of payments problems, as well as a periodic review mechanism. The most significant outcome was the understanding between the two customs authorities to exchange data on the origin and price of imports under FTA.

This will help address the issues of under-invoicing and misdeclaration by traders. The last round discussed the requests and offers from both the sides for the final lists, which can be concluded in the coming rounds. And that is where things ended.

Is a trade deficit with a larger economy necessarily a sign of economic trouble for the smaller economy? My answer is no.

There have been examples of bilateral economic relations between two unequal partners that have been calibrated with deliberate policy support, mainly by the bigger partner, in a way which brought progress in the smaller partner economy. These examples are Vietnam and China, Thailand and Japan, Mexico and USA, to name a few.

If we look at the current composition of imports from China and the trade deficit it generates, we see that 60pc of the goods are coming on existing FTA concessions and the remaining 40pc are those which are either raw materials or machinery (a large part under CPEC).

Most of the goods under FTA concessions are those which were earlier imported from other sources, but have gradually been diverted towards China. It will also be wrong to place such diversion solely on FTA. Some of the items such as solar panels are gaining market space due to improved quality in recent years.

Without any trade-balancing industrial investments based on Chinese FDI, the repatriations against these projects will also put pressure on the balance of payments between the two countries

However, Pakistan’s export share has been diverted to other countries mainly because of higher tariffs. Hence it is important for Pakistan’s exports to regain their lost ground in Chinese markets. Apart from that, we also need to keep in view the growing import demands in the Chinese market and increase our share in that promising market which imports goods worth $1.7 trillion annually. Not only exports but also importing raw materials and intermediate goods on concessionary tariffs for value addition and export to the global market including China, should also be our priority.

It is also true that market access through any Free Trade Agreement, does not necessarily bring about higher exports or integration into global value chains, unless investments in value addition (primarily manufacturing, expansion and upgradation) also take place, either by local manufacturers or through Foreign Direct Investment (FDIs). Similarly, protection by itself cannot arrest trade deficits if the local or foreign entrepreneurs do not invest in import substitution. Undue protection through very high tariff on imports, especially of raw materials, intermediate goods and machinery which are not locally produced in sufficient quantities to meet demand, only hurt our local industry. The industries and exporters who use these materials become uncompetitive internationally and costly locally, encouraging smuggling.

Hence, both trade liberalisation and protectionism must be calibrated carefully in a balanced trade and investment policy seeking export enhancement and import substitution. For these objectives to be achieved, the primacy has to be given to attracting investments in the manufacturing sector. The most obvious opportunity in China-Pakistan economic relations is the current phase of CPEC: industrial cooperation.

The first phase of CPEC successfully culminated in laying the foundation of a supporting energy and communication infrastructure. The current phase needs a similar all-encompassing approach to enhance trade and address the challenges of balance of payments between the two countries. The current CPEC investments, while addressing Pakistan’s key challenge of energy deficit and improving connectivity with China are, nonetheless, in non-manufacturing sectors and would require robust growth in industrial activity for the economy to benefit from them. Without any trade-balancing industrial investments based on Chinese FDI, the repatriations against these projects will also put pressure on the balance of payments between the two countries.

The Vietnam model is what is needed to make the China-Pakistan economic relationship (collectively under CPEC and CPFTA) a win-win proposition for the two countries. Apart from the productivity of its workforce, Vietnam became an emerging Asian tiger due to generous and consistent Chinese investments and transfer of technology. Vietnam had very large trade deficits with China, many times higher than Pakistan, but through integration into global value chains, it gained an overall surplus globally, by consistent industrial investments and relocation of industries from China.

Such a possibility is now opening before us, as CPEC shifts gears towards industrial cooperation through Special Economic Zones. In view of the urgency of Pakistan’s balance of payments situation, a shorter-term package consisting of relocation of Chinese industries and investments into export-oriented or import-substituting industries in existing industrial zones needs to be pursued.

How we benefit from our growing engagement with China requires a comprehensive approach at the policy level (in both countries) for trade and investment to support sustainable economic collaboration.

Published in Dawn, May 13th, 2018