SBP underlines the need to gain a foothold in the global value chains (GVCs)  

KARACHI: The State Bank of Pakistan (SBP), in its First Quarterly Report FY 2020 on the State of Economy, has underlined the need to build on gains on the ease of doing business front. Side by side, it is equally important for firms to leverage on the facilitative policies, particularly the export-promotion incentives, and gain a foothold in the global value chains (GVCs).

“Increased participation in the GVCs would not only align the country’s product mix with trends in global demand, but also put the exports on a sustainable growth path,” it said.

Global Value Chains (GVCs) had been the most prominent force behind globalization and world GDP growth during 1995-2008. Over the past two decades, the scale and patterns of global trade have become organized around and governed by the GVCs. This is evident from the fact that GVC-related trade accounts for 48.1 percent of the total global trade.

While countries like Vietnam and Bangladesh have reaped substantial returns in terms of export and economic growth over the past two decades via participation in the GVCs, Pakistan has been unable to establish a similar presence in the global production and supply networks.

However, the key developments pertaining to GVCs currently underway provide the country with an opportunity to realign its trade activities and improve integration within the existing and emerging global value chains.

First, the manufacturing activities around the world are becoming more services oriented. Trade flows in value-added terms reveal that transport logistics, communication, and financial services play important roles in GVCs. Resultantly, the value created by services as intermediate inputs represent over one-third of total GVA of global manufacturing, and services exports figures in gross terms (43 percent) vastly understate the exports of services in value-added terms (21 percent).

Second, information technologies are undergoing a revolutionary transformation. Businesses and consumers alike are transitioning from the usage of social media, analytics, and cloud computing to areas such as distributed ledger technology, artificial intelligence, reality augmentation, and quantum computing.

Together, these developments stand to facilitate and increase the transfer and accessibility of information exponentially, thereby enabling more processes and activities to be fragmented and/or outsourced.

Third, with consumption patterns changing and becoming more personalized, the GVCs are also undergoing a transformation, from mass production towards mass customization. This is resulting in the creation of multiple value chains for similar products, with input materials being sourced from various locations instead of relying on suppliers from a single geographical location.

The wage increases in production countries such as China are also pushing firms to relocate to alternate destinations to keep their competitive edge intact.

Fourth, the gradual rise in demand in the emerging economies, particularly China and India, is increasing the attraction of such destinations not only as an outsourcing market but also as a selling one. This rerouting of value chains is expected to continue over the next decade and beyond as emerging economies are expected to achieve 50 percent share in total global demand by 2030 fueled by consistently high retail market growth rates.

Keeping in view these developments, Pakistan must utilize this opportunity and deepen the linkage of its manufacturing activities with the global value chains to steer its exports towards a sustainable growth trajectory, akin to Bangladesh’s performance in the textile sector.

In this backdrop, the following sub-section analyzes the potential of Pakistani firms to reorient their businesses within the established chains pertaining to textiles, electronics and ICT sectors. In the long run, the country holds the potential to target even the middle- to higher end segments of the GVCs, given that the right mix of policies is adopted.

In order to increase participation along the GVCs, a low-hanging fruit can be to target sectors where domestic players already have established global relationships, such as textiles and Business Process Outsourcing (BPO).

This strategy would not only provide an opportunity to deepen the present relationships, but also allow firms to branch out and diversify both their product base (towards higher value-added items) and geographic sources/destinations.

Going forward, however, Pakistan must tap sectors, such as light engineering, appliances manufacturing and services, whose shares in GVC trade are consistently rising.

According to the report, Pakistan’s economy moved progressively along the adjustment path during the first quarter of FY20. The macroeconomic stabilization process picked up momentum with the initiation of the IMF’s Extended Fund Facility program: the SBP continued to keep the monetary policy consistent with the medium-term inflation target; whereas, consolidation efforts were visible on the fiscal front.

Furthermore, a market-based exchange rate system was implemented, to which the interbank foreign exchange market adjusted relatively well. Notably, the government avoided deficit monetization, including rollover of SBP debt and actively pursued documentation efforts.

According to the report, the payoff from ongoing stabilization efforts has become visible in the form of declining twin deficits. The current account deficit in Q1-FY20 fell to less than half of last year’s level, primarily on the back of significant import compression. Owing to low unit prices, exports growth remained low.

However, in volumetric terms exports witnessed noticeable growth. On the fiscal front, the overall deficit remained lower as compared to the same period last year, and the primary balance recorded a surplus for the first time in 7 quarters. This improvement was made possible through both revenue enhancing and expenditure control measures. Importantly, development expenditures witnessed a sharp growth of 30.5 percent during the quarter.

In case of GDP, the report noted that the revised estimates for the kharif season suggest that the production of important crops is likely to fall short of target for FY20. The large-scale manufacturing sector witnessed a decline of 5.9 percent in Q1-FY20 on YoY basis. This contraction was broad-based, as construction-allied industries, petroleum and automobile industries continued on downward path. In contrast, previous corrections in the exchange rate helped the export-oriented industries, as reflected in the relatively better performance of textiles and leather. On balance, however, achieving the real GDP growth target of 4 percent appears unlikely.

The report further highlighted that the average headline CPI inflation reached 11.5 percent in Q1-FY20, extending the steep upward trend persistent since the beginning of FY19. Not only this level was double the inflation observed in the same quarter last year, it was also the highest level of quarterly inflation since Q4-FY12.

This outcome was attributed to the lagged pass-through of the exchange rate depreciation towards the end of FY19; rationalization of energy tariffs; and revenue-led fiscal measures taken in the budget 2019-20, which included the imposition of federal excise duty on a number of consumer items, and the ending of the zero-rating regime for export-oriented sectors and of the reduced GST regime on sugar.

On the external front, the balance of payments continued to improve during Q1-FY20. Beside significant improvement in trade deficit, and with the receipt of the first EFF tranche from the IMF and increase in foreign portfolio investment, the current account gap was plugged by the available financial flows. These inflows also helped the SBP to increase its foreign exchange reserves by US$ 656.2 million and reduce its net forward liabilities by US$ 1.3 billion during the quarter.

Going forward, the report emphasizes, it is vital that the government continues to address the underlying structural vulnerabilities and put the economy on a balanced and sustainable growth trajectory.

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