The Pakistan Muslim League-Nawaz government seems to have been caught between a rock and a hard place as serious external account imbalances resurface in an election year, hardly 13 months after the completion of the $6.7 billion IMF balance-of-payments support loan arrangement.

The central bank recognises the dilemma facing the government, urging it in a new report to boost exports, encourage payments from Pakistanis working abroad and woo higher foreign private investment to deal with the growing current account deficit, depleting official dollar stocks and stave off a foreign currency crisis.

Simultaneously, the bank also acknowledges that the government will have to continue relying on foreign borrowings (and accumulate expensive, short-term debt) because the effort to increase exports and workers’ remittances and to pull foreign investors will take some time to materialise.

In the interim, the State Bank of Pakistan notes in its annual State of the Economy report for 2016-17 that the country will have to rely mainly on external borrowings and take stopgap measures to contain trade deficit.

The current account deficit widened to $12.1bn last financial year from less than $5bn a year ago as the trade gap rose to an all-time high of $26.9bn on the back of an 18 per cent surge in imports and 1.3pc dip in exports.

Banks’ liquid foreign currency stocks too have depleted to less than $14bn in the middle of this month from $18.9bn a year ago, after rising for three consecutive years on debt-creating foreign inflows as the trade deficit expands, payments from overseas Pakistanis drop and foreign direct investment (FDI) remains lower-than-expected.

The central bank acknowledges that the government will have to rely on foreign borrowing as the effort to increase exports, workers’ remittances and foreign investment will take some time to materialise

The data for the first two months (July and August) of the current fiscal year shows that the current account deficit doubled to $2.6bn from a year ago.

Like the government, the central bank also blames increasing growth momentum and ongoing power and transport projects under the China-Pakistan Economic Corridor (CPEC) initiative for the surge in imports, emergence of external account imbalance and depletion of official foreign currency reserves.

The weakening external account has recently triggered calls for significant devaluation of the rupee to keep off a foreign currency crisis, with many forecasting another IMF bailout. The government, however, has dismissed speculations of devaluation and imposed regulatory duty on 250 items to narrow the trade gap.

The World Bank estimates Pakistan’s external financing requirements for paying its import bills and debt to spike to $31bn, or 9pc of GDP, this year. Government’s estimates put its financing needs to be a little more than $18bn.

Analysts contend that the government will have to raise expensive, short-term debt to finance its external debt and let its foreign currency reserves bleed to pay its bills.

Last year, it had to scale up its foreign borrowings to $10.1bn — including expensive, short-term debt of $4.4bn that emerged as a top source of official foreign exchange inflows — to pay for its bills because inflows and foreign investment fell short of initial expectations.

The SBP says the government was forced to obtain expensive, commercial loans because net foreign direct investment of $2.4bn received last year fell far short of initial estimates of $4.5bn.

“The key assumption was that CPEC-related power projects would receive the bulk of this higher foreign investment. However, as it turned out, the actual inflow of investment into the power sector declined 31.4pc.

“Moreover, the sector’s share within total FDI, as well as in overall FDI received from China, declined significantly. Most power firms that had received Chinese FDI in 2015-16 continued to receive investment from the country in 2016-17, albeit in lower volumes,” the bank noted.

Overseas Investors Chamber of Commerce and Industry CEO Abdul Aleem says foreign investment inflows are critical for emerging markets like Pakistan to create jobs, enhance productivity, ensure transfer of technology, boost competition in the domestic market and increase exports.

“Though the FDI inflows in 2016-17 increased by 4.5pc to $2.4bn, these remain only 0.8pc of the country’s GDP. This level of FDI is well below Pakistan’s potential and capacity, as well as FDI inflows recorded in the past,” he argued.

“Pakistan needs significantly higher FDI, at least 3pc of its GDP, to generate growth and create jobs. This is not impossible as foreign investors are interested in coming to Pakistan. With smart strategies, large investment inflows can become a reality.

“But the government will have to leverage business-friendly policies, a fast growing consumer market for a large middle class and the availability of relatively low-cost skilled workforce to ensure FDI inflows on a scale similar to countries like Vietnam, Indonesia and so on.”

He is of the view that Pakistan is currently not getting its due share of FDI on account of several impediments, including negative country perception, inconsistent tax policies focused on the organised sector, and insufficient interaction between policymakers and investors causing delays in settlement of issues like tax refunds.

“We also need to manage inter-provincial coordination issues that are causing concern to both local and foreign investors,” he said.

Financial analyst Shahid Zia agrees. “The government has a choice here: borrow expensive and short-term commercial loans to finance the current account this year as well or tweak its investment policies to attract foreign private investment.

“Like the bank says, short-term loans entail serious implications in terms of rollover and re-pricing risk of the country’s external debt. Foreign investment on the other hand can be hugely beneficial for tackling external account imbalances.”

Published in Dawn, The Business and Finance Weekly, October 16th, 2017