Pakistan Faces High Susceptibility to Balance of Payment Crises, While India Demonstrates Resilience, According to Moody’s
According to Moody's Investors Service, among the South Asian sovereigns, Pakistan emerges as the most susceptible to balance of payment (BOP) crises. In its recent report titled 'Sovereigns – South Asia Low trade openness fuels vulnerability to shocks and curbs growth in the longer run,' the rating agency highlighted Pakistan and Sri Lanka as the two most vulnerable among the four sovereigns.
The report pointed out that both Pakistan and Sri Lanka have faced considerable BOP pressures due to their low levels of exports and foreign direct investment (FDI), coupled with less effective policy management and higher political risk. In contrast, India stands out as the least vulnerable, attributed to its larger and more diversified export sector. Additionally, Moody's noted that India's superior macroeconomic policy management has enabled it to accumulate and maintain sufficient foreign exchange reserves.
"The report highlighted that both Pakistan and Sri Lanka are more susceptible to economic shocks due to their constrained trade openness, insufficiently diversified exports, ineffective macroeconomic policy management, and elevated political risks. In contrast, India is less vulnerable, attributed to a larger, diverse export sector and superior macroeconomic policy management, ensuring ample foreign exchange reserves."
The report highlighted the substantial disparity in infrastructure strength, with Pakistan and Sri Lanka trailing behind India, resulting in higher trade costs. Within South Asia, Pakistan and Bangladesh were noted as having the lowest export levels at 10.5% and 12.9% of GDP, respectively, according to the credit rating agency.
Sri Lanka and India, with more developed service export sectors, boasted higher export percentages at 21.5% and 22.4% of GDP, respectively. The credit rating agency also pointed out that Pakistan's export potential is approximately six times its current exports, while Bangladesh, India, and Sri Lanka have export potentials ranging from two to three times their current exports.
Furthermore, the report underscored the very weak fiscal policy effectiveness in both Pakistan and Sri Lanka, contributing to more significant macroeconomic imbalances that hinder their ability to adjust to external shocks.
Both nations consistently grapple with ongoing current account deficits, primarily stemming from low saving rates amid consistently substantial government fiscal deficits, according to the report.
Moody's highlighted that both countries face elevated domestic political risks, which disrupt policymaking and impede their ability to attract foreign direct investments (FDI) essential for building and maintaining adequate reserves. The limited influx of FDI, in turn, hampers their engagement in global value chains. Notably, Pakistan and Sri Lanka have experienced net inflows of FDI averaging 0.6% and 1.0% of GDP, respectively, from 2013 to 2022.
In the fiscal year 2022-23, the credit profiles of Pakistan and Sri Lanka witnessed a significant deterioration. A global shock in commodity prices coincided with expansionary fiscal policies, resulting in heightened import demand. Simultaneously, global financial conditions tightened, leading to a rapid widening of their current account deficits and substantial depletion of foreign exchange reserves.
Pakistan's foreign exchange reserves plummeted to a cycle low of $2.6 billion at the end of May 2023, sufficient to cover less than one month of imports. However, reserves have shown some recovery, reaching $7.5 billion as of October 2023.
In December 2022, Sri Lanka's reserves declined to $1.9 billion, down from $2.7 billion a year earlier. Although Bangladesh experienced a slight weakening in its credit profile, it was to a lesser extent, as it possessed more reserves compared to Pakistan and Sri Lanka, enabling it to absorb the impact of the global energy price shock that occurred in early 2022.
According to World Bank research, Pakistan's tariff structure is among the steepest globally, fostering an environment conducive to export substitution. The South Asian sovereigns also exhibit a high prevalence of non-tariff trade barriers, such as labeling requirements and administrative fees, further promoting export substitution.
In contrast, Bangladesh, Pakistan, and Sri Lanka lag behind in various aspects, including political stability, governance, trade infrastructure and policies, and labor quality. These notable shortcomings are anticipated to hinder their ability to credibly develop and diversify their export sectors, as highlighted in the report.
Additionally, Moody's pointed out that all three countries grapple with varying degrees of macroeconomic imbalances, further limiting their capacity to invest in the necessary infrastructure and education crucial for supporting the development of their external sectors.
