Balancing trade openness and forex reserves

LAHORE: Pakistan’s trade policy is currently in disarray, with selective import restrictions leaving traders confused. While the country grapples with a shortage of foreign exchange reserves, certain high-cost, non-essential imports are still allowed -- albeit with high tariffs -- as if revenue generation is being prioritized over safeguarding forex reserves.

Openness, in economic terms, generally refers to policies that encourage trade, investment and the movement of capital and people across borders. Such openness can stimulate an economy by fostering competition, enhancing productivity, promoting innovation and providing consumers with a wider variety of goods at lower prices. However, in countries like Pakistan, where foreign exchange reserves are low, finding the right balance between openness and protectionism is crucial.

For a country facing forex shortages like Pakistan, liberalizing imports without any restrictions can quickly drain reserves. Therefore, prioritizing essential imports -- such as raw materials over finished goods -- is a commonly adopted strategy. Importing raw materials supports domestic production and job creation, while importing finished goods places a burden on reserves without contributing significantly to local economic activity.

In Pakistan, permitting the import of vehicles, used cars, or imported food items consumes substantial foreign exchange. With the wealthy controlling nearly 80 per cent of the country’s wealth, they have little difficulty in paying high duties and taxes. While this enhances their lifestyle, it places significant strain on foreign exchange reserves, at times forcing the government to even restrict raw material imports.

Limiting imports to essential raw materials can help sustain industrial productivity while conserving foreign exchange. However, this approach has its trade-offs. Restricting finished goods imports could raise prices for consumers and reduce competition. Moreover, if industries depend heavily on imported machinery or intermediate goods, they may still face challenges even if raw materials are prioritized.

If Pakistan were to adopt a fully liberalized import policy, its reserves could deplete rapidly, particularly given the demand for non-essential goods. A selective import strategy, coupled with stronger export promotion and efforts to attract foreign direct investment, could strike a balance between openness and safeguarding reserves.

One significant issue in Pakistan is under-invoicing, especially for finished imported goods. Importers often declare lower prices to reduce the duties and taxes they owe, creating unfair competition for locally produced goods.

One proposed solution is to charge sales tax on all imported products based on the sales tax paid by similar domestically produced items. However, this approach is challenging, as it could lead to disputes over product comparability and tax rates.

Strengthening the customs valuation process using international reference pricing could help reduce under-invoicing. Implementing digital platforms for real-time data sharing between tax authorities and customs, along with utilizing international trade databases, could help detect discrepancies. Unfortunately, countries where under-invoicing is prevalent do not often share real-time data with Pakistani authorities.

Introducing mandatory third-party audits for high-risk importers could improve transparency. Stricter penalties and enforcement against under-invoicing could also serve as a deterrent. However, in Pakistan, traders caught under-invoicing are often let off after paying the actual duties and taxes, along with a minor penalty. Those who challenge under-invoiced imports are required to deposit 25 per cent of the invoice amount, only to face long delays in receiving refunds when the under-invoicing trader is allowed to clear the goods by matching the challenger’s offer.

For Pakistan, a balanced approach is essential. Authorities must encourage the import of raw materials to fuel domestic production, while monitoring and regulating non-essential finished goods imports to conserve foreign exchange. While trade openness can boost the economy, it must be carefully managed to avoid undue pressure on forex reserves and to ensure that domestic industries can compete on fair terms.