1 2 This Technical Note is an updated version of the Pakistan Trade Policy Note that was prepared at the request of the Government of Pakistan in 2016. It was prepared by a World Bank team composed of Nadia Rocha (Senior Economist) and Gonzalo Varela (Senior Economist) from the Macroeconomic, Trade and Investment Global Practice of the World Bank Group. We thank Guillermo Arenas (Economist), Sarur Chaudhary (Consultant), Miles McKenna (Analyst), Michael Ferrantino (Lead Economist) and Adnan Ghumman (Economist) for their contributions, and Enrique Blanco, Michael Ferrantino, Manuela Francisco, Sanjay Kathuria, Jose Guilherme Reis, and Connor Spreng for their valuable comments. The note was edited by Deborah Davis. 3 CONTENTS Acronyms 5 Executive Summary 6 1. Background and Objectives 10 2. Pakistan’s Trade and Investment Competitiveness: Current Patterns 14 3. Drivers of Pakistan’s Trade and Investment 24 4. What Would It Take to Move Pakistan’s Trade Policy Forward? 39 References 45 Figures Figure 1.1: GDP evolution compared to peers, 2007–17 11 Figure 1.2: Pakistan’s exports compared to peers, 2005–17 12 Figure 1.3: Trade-to-GDP shares, selected countries 13 Figure 2.1: Pakistan’s exports and imports (goods and services), 2005–17 15 Figure 2.2a: Foreign value added in gross exports 16 Figure 2.2b: Domestic value added in third country exports 16 Figure 2.3: Services export composition as percentage of total exports, 2005–17 17 Figure 2.4: Trade in services as percentage of GDP, 2006–17 18 Figure 2.5: HH product index, 2011–16 18 Figure 2.6: Export concentration by product 19 Figure 2.7: Export concentration by geography 19 Figure 2.8: Pakistan’s bilateral trade potential 20 Figure 2.9: Pakistan’s export sophistication compared to peers 21 Figure 2.10: Share of apparel exports by fabric content, 2012 21 Figure 2.11: Prices for Pakistan’s main export products, 2015–16 22 Figure 2.12: Evolution of export relationships, Pakistan compared to India and Vietnam 23 Figure 3.1: Real and nominal effective exchange rate in Pakistan 25 Figure 3.2: Simple average tariff, Pakistan compared to South Asia and East Asia & Pacific, 2006–16 26 Figure 3.3: Pakistan’s weighted average tariff by category, 2016 27 Figure 3.4: Pakistan’s weighted average tariff, 2006–16 29 Figure 3.5: Import value under exemptions from customs duties as percentage of total imports 30 Figure 3.6: Value of customs duty exemptions (PR billions) 31 Figure 3.7: Percentage of duty exemptions claimed by top 250 firms 31 Figure 3.8: Time required to accomplish selected doing business tasks 33 Figure 3.9: FDI net inflows as percentage of GDP, Pakistan compared to South Asia 34 Figure 3.10 Share of announced FDI inflows by technology level 35 Figure 3.11 Relationship between STRI and imports and exports, 2009 35 Figure 3.12 STRI and development and value added in services as percentage of GDP, 2013 36 Figure 3.13 Cost to export and documents required to export, Pakistan and peers 37 Figure 3.14 Logistics performance indicators, 2018 compared to 2010 37 Figure 3.15 Logistics Performance Index, comparison with peer group, 2018 38 Tables Table 1.1: Trade costs, 2014 13 Table 2.1: Sectoral contribution to GDP growth, 2007–17 17 Table 3.1: Prevalence of regulatory duties, FY2013–FY2016 29 Table 3.2: Logistics performance index (LPI) 38 Table 4.1: Revenue from customs duties, PR millions, 2004/05–2016/17 41 Box Box 4.1 Learning from private sector consultations 40 4 ACRONYMS ADs Additional Duties APTTA Afghanistan–Pakistan Transit Trade Agreement CARs Central Asian Republics CPEC China–Pakistan Economic Corridor DTRE Duty and Tax Remission for Export Program EPZ Export Processing Zone ESCAP United Nations Economic and Social Commission for Asia and the Pacific FBR Federal Board of Revenue FDI Foreign Direct Investment FTA Free Trade Agreement GDP Gross Domestic Product GVC Global Value Chain HH Index Herfindahl-Hirschman Index JEC Joint Economic Commission (Pakistan and Afghanistan) LPI Logistics Performance Index OECD Organisation for Economic Co-operation and Development OTRI Overall Trade Restrictiveness Index PR Pakistani Rupee PTA Preferential Trade Arrangements RDs Regulatory Duties SKp Services Knowledge Platform SRO Special Regulatory Order STRI Services Trade Restrictiveness Index TFA Trade Facilitation Agreement WeBOC Web-based Software for Custom Clearance 5 EXECUTIVE SUMMARY KEY MESSAGES: Pakistan needs to change its growth model to one led by investment and productivity. Integration into the global economy can be a powerful platform, currently untapped due, in part, to the anti-export bias of its trade policies. To turn the lagging export sector into an engine of growth and job creation, and turn Pakistan into a trade and transit hub, the following actions are recommended: • Rationalize tariff policy by committing to a transparent tariff structure with low average tariffs, minimal dispersion and less discretion. • Revise duty exemption schemes to make them more accessible to all firms regardless of their size. • Take steps to improve trade facilitation to reduce the time and cost of importing and exporting. • Leverage the China–Pakistan Economic Corridor (CPEC) to improve regional connectivity and expand participation in regional value chains. • Improve the investment climate and the regulatory environment to attract investment in more sophisticated and higher value added goods and services. • Enhance interagency coordination in the development and implementation of a coherent and pro-export trade policy. 6 EXECUTIVE SUMMARY Analysis and findings The Government’s efforts to reduce tariffs have lagged regional trends. Pakistan’s simple average tariff Evidence suggests that Pakistan has the potential rate declined 2.31 percentage points between 2006 and for much faster and more diversified economic 2016, compared to 3.28 for South Asia and 0.94 percent for growth. While the country has been outpacing global East Asia, from an already lower rate. Pakistan also has one economic growth, it has not experienced the explosive of the highest weighted average tariff rate differentials in growth of its South Asian peers. Over the period 2008-2017, the region and in the world, with an average tariff difference South Asian countries have been growing by 6.6 percent a between consumer goods and raw materials of 10.39 year, on average, while Pakistan has grown the much slower percentage points in 2016, and between intermediate goods rate of 3.7 percent. and raw materials of 2.21 percentage points. Energizing trade can help Pakistan to realize its Pakistan’s failure to reform its trade policy to better growth potential. Pakistan’s trade-to-GDP ratio was close foster export competitiveness can be attributed to that of its South Asian neighbors in the early 2000s, but in part to institutional fragmentation within the then fell behind as Pakistan failed to fully leverage export Government. Multiple agencies have a mandate to make trade as an engine of growth. The export performance of policy decisions that have significant impacts on trade and some of Pakistan’s major competitors is revealing. From competitiveness. Foremost among them are the Ministry of 2005 to 2017, South Asia’s exports of goods and services Commerce, the Federal Board of Revenue and the Ministry of increased by 165 percent, Thailand’s by 136 percent, and Finance. Moreover, policy decisions regarding the exchange Vietnam’s by 519 percent. In comparison, Pakistan’s exports rate, taxes and refunds appear to be driven by short-term increased by only 50 percent, from US$19.1 billion to US$28.7 fiscal considerations rather than longer-term strategic goals. billion, over the same period. This fragmentation has resulted in different agencies Pakistan’s inward-oriented trade policies have sometimes working at cross purposes. Efforts to reduce had the effect of stalling Pakistan’s integration tariffs have been offset by the introduction of alternative into regional and global value chains (GVCs). These protection instruments such as Regulatory Duties (RDs) and modern-day production networks rely on the components firm-specific Special Regulatory Orders (SROs). While in some of final products being able to move quickly and cost cases, the aim of high tariffs, along with RDs and SROs, has efficiently among multiple countries. To facilitate integration been to protect domestic production, in practice they have into these networks, countries have made efforts to reduce sheltered firms from competition, which has resulted in lower trade costs. Pakistan has not. Rather, trade policy has productivity and inefficient allocation of resources. reverted to protectionism through, for example, the use of increased duties to curb imports and reduce current account In addition to tariffs, RDs and SROs, other obstacles imbalances or to shelter incumbent firms from competition. At to global integration include a heavy regulatory the same time, the increased use of ad hoc tariff exemptions burden and perceived risks to investing and for imported intermediates has benefited mainly a few large operating in the country, which have hurt efforts to firms and put small and medium exporters – including highly attract foreign direct investment (FDI). Total foreign innovative firms – at a disadvantage. In trade facilitation, as investment as a percentage of GDP declined from 3.7 to well, efforts to keep trade costs low have not kept pace with 0.9 percent between 2007 and 2017. While the average FDI competitors. for South Asia remained at 1.9 percent of GDP, it was 1.2 for 7 EXECUTIVE SUMMARY Pakistan. And while Pakistan’s peers have leveraged FDI Pakistan’s exports are concentrated in a small to support high-potential and high-growth industries in number of products with low levels of sophistication. their export sectors, Pakistan has managed to attract Chief among these is cotton. Over the past decade, products foreign investment only in industries with low levels classified in Pakistan as “cotton manufactures” have of sophistication, which has done little to increase its accounted for approximately 55 percent of the entire export competitiveness. basket. Looking at sectors more broadly, Pakistan’s three largest exports—textiles, leather and rice—have accounted Growth and competitiveness are also inhibited by for more than 70 percent of total exports—a share that has inefficient trade facilitation policies, weak logistics remained unchanged over the decade. Upgrading Pakistan’s services, and underdeveloped infrastructure. Costs export sector will require a coordinated reform effort, outlined associated with logistics—both monetary costs and costs below. associated with processing times—are considerably higher in Pakistan than in OECD countries. As of 2017, border and documentary compliance to export from Karachi took 130 Recommendations hours compared to just 15 hours in OECD countries. To import took 272 hours compared to 12 hours in OECD. More efficient Make trade a centerpiece of the national development customs and border management will help to reduce these strategy in recognition of its dual role in diversified trade barriers. growth and poverty reduction. A series of actions in the areas of trade policy, trade facilitation and connectivity, These constraints have made it difficult for Pakistan and institutional coordination could potentially stimulate to fully exploit its proximity to China, a trade Pakistan’s growth through increased trade and investment powerhouse, with which it has a free trade agreement. competitiveness. Partial equilibrium analysis shows that the Pakistan–China free trade agreement (FTA) has had only a modest impact on the Rationalize tariff policy to su pport trade bilateral trade. Over the past seven years, Pakistan’s imports competitiveness, taking into consideration the from China increased by 68 percent but only 4.6 percent impact on revenue and domestic producers. Customs 1 of the total increase can be attributed to the FTA . Nor did duties accounted for only 10.4 percent of tax revenue in the FTA have a dramatic effect on export diversification, as 2017. An inter-ministerial committee could develop a tariff the products that accounted for this increase were primarily reform roadmap for achieving a simple and transparent tariff the familiar exports of cotton yarn, linens, and leather. structure with low average tariffs and minimum dispersion— These results suggest that Pakistan has much to gain from one that would boost private sector competitiveness while renegotiating the terms of the FTA. ensuring minimum impact on revenue collection. For maximum impact, the roadmap would also have to tackle the issue of All in all, the anti-export bias of Pakistan’s trade RDs and SROs. policy has made it more difficult for outward-looking firms to grow by accessing global markets. It has also Continue developing and implementing major regional discouraged foreign firms from considering Pakistan as a connectivity initiatives, leveraging the China- destination for efficiency-seeking investments. As a result, Pakistan Economic Corridor project as a first step in Pakistan’s exports have remained stagnant, undiversified and improving logistics performance and trade facilitation. unsophisticated. The Government is right to focus on developing a trade and 1_Ferrantino and Rehman, forthcoming. 8 EXECUTIVE SUMMARY transit network that installs Pakistan as an economic corridor Enhance interagency coordination to support a between Central Asia and South Asia. Specific actions to coherent trade policy. An inter-ministerial committee achieve this goal could include (a) conducting a diagnostic comprising representatives from the Ministry of Finance, the of the elements necessary to support improved transit Ministry of Commerce, the Federal Board of Revenue, and and commercial trade; (b) adopting a modern risk-based the Board of Investment could be empowered to ensure approach to regulatory compliance management for cross- policy coherence and strike a balance between short-term border trade, backed by a robust and enabling legislative revenue needs and long-term strategic aims. In particular, the framework; (c) completing the operationalization of an committee could prioritize eliminating unnecessary tariff and automated, simplified and transparent system of regulatory non-tariff barriers to trade in order to ensure that potential controls by all border agencies; and (d) fully implementing a exports are not handicapped by the unavailability of quality national single window (NSW) system to reduce trade costs inputs at world prices. and improve connectivity. Foster new and stronger relationships with trading Develop policies that can boost the competitiveness partners to prepare the ground for deeper integration of the services sector, which could help to into regional and global value chains. Integration increase services exports and simultaneously help with other countries in the region and neighboring regions, manufacturers that rely on backbone services. particularly East Asia, will allow Pakistan to diversify both its Actions aimed at increasing the relative share of domestic product basket and markets. Revision and full implementation services used by exporters would help to create a virtuous of the Afghanistan–Pakistan Transit Trade Agreement (APTTA) cycle of economic upgrading and value addition. A national is fundamental to improve Pakistan’s role as a trade and transit services export promotion strategy could also be developed, hub. Renegotiation of the Preferential Trade Agreement (PTA) including such actions as (a) improving services trade with China to fully exploit the potential of that vast market is statistics; (b) undertaking a regulatory diagnostic for services also of crucial importance. Finally, full normalization of trade trade and investment; (c) undertaking a competitiveness relations with India would allow Pakistan to benefit from India’s assessment for key services sectors; and (d) developing a fast growth and promote complementarities, including value- strategy for negotiating with major partners. chain activities and investment potential. Continue improving the main supply-side challenges that affect Pakistan’s trade competitiveness. The first step could be to use special economic zones to attract higher-quality FDI until the overall investment climate improves. The Government could also focus on addressing constraints related to access to energy, access to finance, skills development and business regulations. To identify pathways to improve the business climate, the Government could consolidate all business regulations and bring them into the public domain through an accessible platform. Public feedback could then assist in reviewing the regulations and assessing their impact on business and investment, particularly in the export sectors. 9 10 1.BACKGROUND AND OBJECTIVES The Pakistan Vision 2025 strategy aims to make equivalent to 1.7 months of imports as of August 2018. Pakistan Pakistan a hub of regional trade and commerce and will need to address these macroeconomic imbalances in the 2 increase exports to US$150 billion by 2025. With near term in order to sustain economic growth. exports below one-fifth of this target in 2017, reaching it will require greater integration into the global market while Despite the recent acceleration, Pakistan’s average 3 achieving and maintaining macroeconomic stability. This note economic growth has been below that of the region looks at where Pakistan stands in terms of various aspects of during the past decade. At a time of declining growth in integration – growth patterns, diversification, the quality of its the developed world, regions such as South Asia have played 4 exports and survival (persistence) of its trading relationships. an important role in boosting global growth. While Pakistan It then discusses how integration can be supported to boost has grown – reaching 5.8 in fiscal year 2018, on average, by 3.7 economic growth and development. percent per year between 2008-2017, comparator countries both in and outside the region have grown at considerably higher rates. The economy of the South Asia region as a Macroeconomic background whole has grown, on average, by 6.6 percent over the last decade, driven primarily by high growth in India. Growth Pakistan’s economy faces several challenges on the in Pakistan has picked up in recent years (Figure 1.1), led by macroeconomic front. As a result of limited revenue growth growth in the services sector and supported by low oil prices. and large increases in recurrent spending at both the federal However, despite the generally positive trend, there is a need and provincial levels, the fiscal deficit reached a high of 6.5 to re-energize and reinvigorate critical economic sectors to percent of GDP in fiscal year 2018. The current account deficit ensure that Pakistan can grow at the 6 to 7 percent annual increased to 5.8 percent of GDP, up from 4.1 percent in the rate required to promote socioeconomic development and previous fiscal year, while foreign exchange reserves are generate jobs for a growing population. Figure 1.1: GDP evolution compared to peers, 2007–17. Source: World Development Indicators, World Bank. Note: GDP figures are relative to each country’s corresponding GDP in 2007. 2_Pakistan Vision 2025, which was formulated by the Ministry of Planning, Development and Reforms, establishes a set of goals pertaining to human, social, and economic development in the country. 3_Preliminary figures from the State Bank of Pakistan place the country’s exports of goods and services in FY2017 at US$28 billion. 4_Persistence refers to the survival rate over successive years of new product-market relationships of at least US$10,000. 11 1.BACKGROUND AND OBJECTIVES Trade has not been fully leveraged to catalyze growth dropped to 25.8 percent since then, Thailand’s and Vietnam’s in Pakistan. During 2005–17, Pakistan’s exports of goods increased to 121.7 percent and 200.3 percent respectively. and services rose from US$19.1 billion to US$28.7 billion (an Pakistan’s low trade-to-GDP ratio indicates that it has been average of 3.5 percent a year), compared to an increase from under-trading compared to its peers for the past 20 years US$264.8 billion to US$701.5 billion (8.5 percent a year) in (Figure 1.3). South Asia; US$36.7 billion to US$227.3 billion (16.4 percent a year) in Vietnam; and US$12.9 billion to US$30.5 billion Pakistan’s limited integration into global markets, (7.4 percent a year) in Thailand (Figure 1.2). Pakistan’s trade along with declining exports in recent years, can be performance has been stagnant over the last 5 years, when attributed to its unfavorable regulatory, policy and exports declined by 1.8 percent a year. At the same time, China business environment. A summary measure of trade 6 and other developing countries, aided by large reductions in costs (Table 1.1), which includes all frictions that induce trade barriers and technological advancements, have become trade flows to be less than normal, shows that Pakistan’s the drivers of global trade. There is now little dispute that in trade costs, both within and outside the region, are much the long run, economies more open to trade show stronger higher than those of comparator countries in South Asia 5 economic growth and overall development performance. and East Asia. Factors such as tariffs, para-tariffs changes, logistics inefficiencies, and nontariff measures contribute to Pakistan’s integration into global markets has been higher trade costs in the country. sluggish over time. In 2000, Pakistan’s trade-to-GDP ratio was 28.1 percent while Thailand’s was 121.3 percent and The objective of this note is to propose an integrated policy Vietnam’s was 111.4 percent. While Pakistan’s trade-to-GDP framework that delineates the means by which Pakistan can Figure 1.2: Pakistan’s exports compared to peers, 2005–17. Source: UNCTAD. 5_Dollar and Kraay 2002, 2004; Papageorgiou, Michaely and Choksi 1991; Winters, McCulloch and McKay 2004. 6_Trade costs in agriculture and manufactured goods are computed using the Inverse Gravity Framework (Novy 2009), which estimates trade costs for each country pair using bilateral trade and gross national output. 12 1.BACKGROUND AND OBJECTIVES unlock competitiveness and make its private sector an engine the region and elsewhere at similar levels of development. of trade competitiveness and economic growth. The proposed Section 3 looks at the drivers of Pakistan’s trade outcomes framework is based on a critical analysis of Pakistan’s relative that can be influenced by policy reforms. These drivers trade and investment performance, barriers to trade, and are grouped into four categories: (a) relative prices (the regional and international developments over the years. exchange rate); (b) trade policy; (c) trade facilitation, logistics and infrastructure; and (d) the investment climate. Section Section 2 describes Pakistan’s current patterns of trade and 4 presents policy recommendations, recent initiatives and investment competitiveness compared to other countries in next steps. Figure 1.3: Trade-to-GDP shares, selected countries. Panel A (1999-2003) Panel B (2013-2017) Source: World Development Indicators, World Bank. Table 1.1: Trade costs, Pakistan and comparator countries, 2014. India Pakistan Vietnam China Thailand Malaysia Outside region 130.50 183.49 102.42 100.00 131.61 119.04 Within region 145.23 176.71 78.43 100.00 81.73 76.09 Source: World Bank staff calculations based on data from the ESCAP-World Bank International Trade Costs database. Note: Figures are relative to trade costs for China (=100) for both outside and within region. China’s cost estimates are from 2013. Higher scores imply higher costs. 13 14 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS This section assesses Pakistan’s competitiveness Pakistan has been losing export competitiveness in along four dimensions: (a) growth; (b) diversification world markets for more than a decade. While China’s across products and markets; (c) quality; and (d) survival share in world trade doubled and Vietnam’s more than tripled (persistence) of its trading relationships. It also discusses since 2005, Pakistan’s share dropped from 0.15 percent in the trends observed in Pakistan’s exports along each of 2005 to 0.13 percent in 2017. This number is put in perspective these dimensions. when further broken down by markets and products. During 2014–17, Pakistan managed to increase its export share of goods in only 11 of its 20 biggest export markets. At the same Growth of Exports time, Pakistan’s exports to China dropped by 34.84 percent, compared to a decline in world exports to China of 14.51 Pakistan’s export performance has been lagging in percent. Similarly, world exports to the United Arab Emirates recent years, with earnings of US$28 billion in FY2017, dropped by 21.94 percent during 2014–17, while Pakistan’s well below the US$31.5 billion achieved in FY2011. exports dropped by 34.81 percent. Pakistan’s higher decay Although total exports increased in FY2017 compared to rate as opposed to the world decay rate for China and the FY2016, reversing a declining trend, this lag in performance United Arab Emirates points to the existence of supply- was all the more pronounced due to a consistent increase side constraints in Pakistan that have hindered growth in in imports and the import bill over the years, despite a steep exports. These constraints and their manifestation in the drop in commodity prices. Imports increased by approximately form of diminished competitiveness are also indicated by 67 percent from 2007 to 2017 (from US$37.6 to US$62.6 the low revealed comparative advantage (RCA) of Pakistan’s 7 billion), while exports increased by only 31 percent. The growth exports. Of the 16 product categories exported by Pakistan differential between imports and exports over the past decade in 2016, the country had an RCA in only four: live animals, has led to an increase in the trade deficit to approximately minerals, hides and skin, and textile cloth. All four categories US$25 billion, the highest it has been since 1976, even higher are classified as low-tech manufactures or natural resource- 8 than in 2008, the year of the global financial crisis (Figure 2.1). based manufactures with low value added. Figure 2.1: Pakistan’s exports and imports (goods and services), 2005–17. Source: UNCTAD. 7_The revealed comparative advantage is an index used to calculate the relative advantage or disadvantage of a certain country in a certain class of goods or services, as evidenced by trade flows. 8_Lall 2000. 15 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Integration into global resilience to downturns all demonstrate the sector’s potential value chains to enhance participation in trade, especially for developing countries. Services are trade enablers: not only are they major Pakistan has been slow to tap into global value chains inputs into agricultural and industrial exports, but efficient and (GVCs) to boost its exports, and is not as integrated reliable services such as transport and logistics are critical as its peers into GVCs as a buyer (i.e., backward for connectivity, competitiveness and the ability to attract participant) of foreign inputs. Peer countries such as FDI. Some services are also a potential source of stand- Malaysia and Vietnam use around 40 percent of foreign value alone exports, including travel and tourism and business and in their gross exports – an indicator of how well integrated they professional services. Pakistan, however, has failed to use are with international production networks - while Pakistan services as a catalyst for export revival, with services exports uses only 7.6 percent (Figure 2.2a). Unlike its peers, Pakistan’s being relatively low and volatile (Figure 2.3). share of foreign value in its exports has declined over time. However, Pakistan is better integrated than its peers as a While Pakistan’s economy has become increasingly seller (i.e., forward participant) of inputs into GVCs. Pakistan’s service oriented over the past 25 years, this shift domestic value added in third country exports was 34 percent has not translated to any significant change in in 2011, while each of its peers had a corresponding share of the composition of the export basket. Over the last below 30 percent (Figure 2.2b). decade, the services sector accounted for more than 50 percent of GDP (59.9 percent in 2017). It has been the The emergence of global value chains as a main fastest-growing sector in the economy, accounting for two- paradigm of global business has shed new light on thirds of economic growth since 2010 (Table 2.1). During the the important role of services in economic growth same period, however, the share of services in total exports 9 and trade competitiveness. The relative dynamism of remained relatively stable, in the range of 16-23 percent the global services sector, its growth in recent years, and its (Figure 2.3). Figure 2.2a: Figure 2.2b: Foreign value added in gross exports. Domestic value added in third-country exports. Sources: Estimates from UNCTAD–Eora; World Bank staff calculations. 7_World Development Indicators show that the services sector accounted for almost 71 percent of global GDP in 2010 and is expanding at a rate considerably higher than the agriculture and manufacturing sectors. Research by UNCTAD also points to the higher contribution to poverty reduction of growth in the services sector compared to growth in the agriculture or manufacturing sectors; and to the relative resilience of services to economic downturns. 16 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Figure 2.3: Services export composition as percentage of total exports, 2005–17. Source: UNCTAD. Table 2.1: Sectoral contribution to GDP growth, 2010–17. Sector 2010 2011 2012 2013 2014 2015 2016 2017 Agriculture 0.05 0.43 0.79 0.58 0.53 0.45 0.03 0.41 Industry 0.71 0.95 0.54 0.16 0.92 1.06 1.18 1.14 Services 1.81 2.24 2.51 2.95 2.60 2.55 3.35 3.83 Real GDP 2.58 3.62 3.84 3.68 4.05 4.06 4.56 5.37 Source: World Development Indicators. Both the gross and the direct shares of Pakistan’s 2017, having grown by 113 percent over the past decade. services exports are below what would be expected In contrast, Pakistan’s services exports grew by only 53.4 according to Pakistan’s level of development. Services percent over the same period, and as of 2017 accounted for represented more than half of total exports from the United 19.9 percent of all exports. Trade in services as a percentage States, Britain, France, Germany and Italy, and nearly one of GDP paints an even starker picture in comparison to peers third of exports from China in 2017. India has been the leader in in the region and beyond. It accounted for 5.3 percent of services exports within the South Asia region, both relatively Pakistan’s total GDP in 2017, compared to 11.27 percent in (as a percentage of total exports) and absolutely. Services India and 26.68 percent in Thailand (Figure 2.4). exports accounted for 38 percent of India’s total exports in 17 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Figure 2.4: Trade in services as percentage of GDP, Pakistan and peers, 2006–17. Source: World Development Indicators. The growth in Pakistan’s services exports has been Diversification of exports grounded primarily in an expansion in financial and telecommunication services. Exports of telecom services Pakistan’s export bundle is relatively concentrated in terms increased by 300 percent over the past decade – from US$252 of both products and markets, leaving the country exposed million in 2007 to US$1 billion in 2017. Exports of financial to price and partner-specific shocks. In 2016, Pakistan services increased by 143 percent over the same period – exported 2,790 products to 195 countries. The Herfindahl- 10 from US$67 million in 2007 to US$163 million in 2017. Transport Hirschman (HH) Index, a measure of dispersion calculated services lagged most other services, contracting by 8.7 percent along the product dimension of the export basket, indicates during 2007–17, likely associated with the sluggish growth of that Pakistan’s bundle in 2016 was less concentrated than merchandise exports. In Vietnam, by comparison, exports of Vietnam’s and on par with India’s (Figure 2.5). Yet, despite transport services grew by nearly 40 percent during 2007-2017 Pakistan’s high number of export products, sectoral and and now account for 20 percent of its total services exports. market concentration is marked (figures 2.6 and 2.7). Figure 2.5: Herfindahl-Hirschman product index, 2011–16. Source: World Integrated Trade Solutions dataset. 10_A country with a preponderance of trade value concentrated in a very few products will have an index value close to 1. Thus, the HH Index is an indicator of the exporter’s vulnerability to trade shocks. The higher the HH value, the greater the vulnerability to shocks. 18 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Figure 2.6: Export concentration by product category. Source: World Integrated Trade Solutions Dataset. Moreover, while Pakistan clearly has a revealed Pakistan’s export market base and penetration, much comparative advantage in the export of textiles and like its product base, have remained stagnant over clothing, it has not fully leveraged this advantage. The the past decade. Six markets have historically accounted 11 Market Penetration Index, which measures the extent to which for more than 60 percent of Pakistan’s exports. Geographically, 12 a country’s exports reach already proven markets, is low for the European Union and the United States represent the Pakistan, with a value of 14.68 in 2017. By comparison, India had a most important destinations for these exports, with the United Market Penetration Index of 27.8 in 2017. The results allude to both States absorbing 17 percent and the European Union taking 34 barriers to trade and to a lack of dynamism, as discussed below. percent (Figure 2.7). Figure 2.7: Export concentration by geography. Source: World Integrated Trade Solutions Dataset. 11_Calculated as the number of countries to which the reporting country exports a particular product divided by the number of countries that report importing the product that year. A low export penetration may signal the presence of barriers to trade that are preventing firms from expanding the number of markets to which they export. 12_Proven markets are countries that report having imported the product during the year. 19 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Figure 2.8: Pakistan’s bilateral trade potential. Billateral Exports (US$ thousands), 2016. Sources: BACI (International Trade Database at the product level); World Bank staff calculations. The export market base has remained concentrated Quality and despite opportunities to diversify and expand exports. 13 sophistication of exports Findings of a gravity analysis suggest that Pakistan can expand exports by leveraging its strategic location, at Pakistan’s exports reflect an overall lack of crossroads between Europe and Asia. Comparing Pakistan’s sophistication and dynamism. The sophistication of observed export (or import) flows with an expected norm (also products for both domestic consumption and export has called trade potential), potential exports (or imports) can be considerable bearing on economic growth. Sophisticated sectors represented by a measure that accounts for the capability of a are more likely to act as a catalyst for broad-based economic 14 16 country and its market access. This is represented graphically growth owing to spillover effects and technological diffusion. by the scatter plot in Figure 2.8. Each dot in the figure is a A study on export sophistication and economic growth in China bilateral trade value and the red marks are Pakistan’s bilateral 17 during 1997–2009 showed that regions specializing in more exports. The solid line represents the bilateral trade predicted sophisticated goods grew faster, indicating the importance 15 by the gravity variables. While Pakistan’s actual exports are of technological innovation in both economic and export above the expected level for many trading partners, there development. Pakistan, however, has been unable to tap into are two crucial partners, China and India, for which expected the global market for goods with high or medium technological exports are substantially greater than those actually observed, 18 content. The technological content of Pakistan’s exports is suggesting the potential for greater exports. very low; high-tech exports constituted less than 1 percent of all 13_The gravity analysis, performed using bilateral trade data to examine Pakistan’s trade potential relative to its actual trade flows, suggests that Pakistan still needs to leverage its strategic location. The gravity model has been extensively used in international trade due to its intuitive empirical and theoretical appeal. Anderson and van Wincoop 2003, Feenstra 2004, and Baldwin and Taglioni (2006), among others, present exhaustive literature reviews on the gravity equation as applied to international trade. 14_The supply capacity of the exporter is approximated by its GDP. Total market access is measured as the sum of the importers’ GDP weighted by their distance from the exporter. 15_Deviations below the line suggest trade underperformance, and deviations above the line suggest trade overperformance. Any deviation from the line points to a residual, which is a departure from the model’s prediction, or in other words, an observation that cannot be explained by the capability of a country or its market access. 16_Anand, Mishra and Spatafora 2012. 17_Jarreau and Poncet 2012. 18_Interestingly, the capabilities to produce high-technology products do exist in the country. An example is the production of sophisticated military equipment. The challenge is to deploy those capabilities in activities that can be successful in reaching export markets. 20 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS exports during 2010–17, while low-tech exports constituted more cotton based, despite the global shift toward apparel than 60 percent of exports during the same period. The shares made of synthetic material. Synthetic fibers, increasingly of low- and high-tech exports in Pakistan’s total exports has in demand for high-performance garments such as sports for the most part remained unchanged over the past 25 years uniforms and protective gear, require a greater degree of (1990–2017), despite Pakistan’s GDP per capita have increased technological sophistication than products with traditional by 180 percent over the same period: as the country’s income fibers. However, Pakistan’s textiles sector is heavily tilted grew, the sophistication of its export bundle did not. toward cotton, which constitutes 84 percent of its apparel exports (Figure 2.10). In comparison, cotton apparel accounted Pakistan’s export-oriented enterprises have continued for only 46 percent of apparel exports globally. to specialize in low-tech, low value-added exports. Comparable countries, both in the region and elsewhere, have had much more success in not only diversifying their Figure 2.9: Pakistan’s export sophistication compared to peers. export basket, but diversifying it toward high-tech, high value- 19 added products (Figure 2.9). China and Malaysia are notable examples, having substantially increased the share of their high-tech exports, resulting in increases in the export bundle sophistication indicators over the last years. India has an even more diversified basket of exports with technological content, with high-tech exports constituting about 73 percent of all exports in 2017. Lack of sophistication is particularly evident in Sources: World Integrated Trade Solutions Database; Export Pakistan’s textiles sector, where production is primarily Sophistication Index (EXPY). Figure 2.10: Share of apparel exports by fabric content, 2012. Source: Lopez-Acevedo and Robertson 2016. Note: MMF = man-made fibers. 19_The comparison is based on the Export Sophistication Index (EXPY), which is used to estimate the level of technological sophistication embodied in a country’s export portfolio. The index aims to capture the productivity level associated with a country’s export and is a proxy for the highest level of sophistication among the set of products a country can produce at a given time. 21 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Pakistan’s exports could also benefit from indicates that the products are of lower quality. In 2015-16, improvements in quality. Pakistan’s main export products, Pakistan was in the lower half among exporters of milled which include rice, textiles and clothing, tend to fetch lower and broken rice in terms of price per unit, and in the bottom prices per unit compared to peer exporters (Figure 2.11), which quarter in exports of toilet and kitchen linens. Figure 2.11: Prices for Pakistan’s main export products, 2015-16. Panel A Panel B Panel C Panel D Source: World Integrated Trade Solutions Database. 22 2.PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS: CURRENT PATTERNS Survival respectively, over the same period (Figure 2.12). The significant rate at which Pakistan’s trade relationships have failed to Exporters in Pakistan have had difficulty retaining survive over the past five years, especially when compared to export relationships. The persistence of trading peers, reflects the inability of Pakistan’s exporters to adjust to relationships is a recognized sign of economic maturity and changing global trade dynamics. This fact holds true even for dynamism. During 2010–15, exporters in Pakistan succeeded Pakistan’s textiles sector, which accounted for 60.5 percent of in maintaining only 34.8 percent of export relationships; that exports in 2017 (and above 55 percent when averaged across is, of the 419 new relationships established in 2010, only 166 the past decade) and has a steep revealed comparative remained in 2015. This is in contrast to India and Vietnam, advantage value of 15.11. Of the 53 textile export relationships which maintained 45.7 and 50.3 percent of their relationships, in 2010, only 27 remained in 2015. Figure 2.12: Evolution of export relationships, Pakistan compared to India and Vietnam, 2010-15. Source: World Integrated Trade Solutions Database. 23 24 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS The declining trend in Pakistan’s relative trade, Recently, however, the emergence of global value investment performance, and competitiveness has chains has generally reduced the effect of exchange structural underpinnings in four areas: (a) relative rates on export competitiveness, particularly in prices; (b) trade policy; (c) trade facilitation, logistics and developing countries. There are three reasons for this. infrastructure; and (d) the overarching investment climate. First, exporting firms use more foreign inputs and add less This section discusses the importance of all four areas for domestic value (on which the real exchange rate, RER, has an trade development in Pakistan. effect) per unit of exports. Second, more international trade is intra-firm, or business-to-business, with more stable supplier- buyer links, which increases the costs of switching suppliers in Real exchange rate and trade case of RER variations. Third, the predominance of large firms in world trade has increased, and these firms find it less costly International experience shows that real currency to hedge against real exchange rate movements along their depreciations boost export competitiveness. For production network. example, if the Pakistani rupee depreciates against the dollar, goods and services produced in Pakistan become cheaper Pakistan’s real effective exchange rate has relative to American ones when expressed in the same appreciated in recent years. Although the Pakistani rupee currency, leading to an expenditure switching away from depreciated in real terms by 22 percent from the 1990s until American into Pakistani goods. Large real depreciations are 2008, it then began to appreciate. Between 2008 and 2017, 20 associated with export surges, although the intensity of this the rupee appreciated by 32.3 percent (Figure 3.1, left panel), boost depends on the type of trade taking place. The effect accelerating during 2013-2016 at a rate of 6.2 percent per is larger in developing countries, where market failures that year. The real appreciation was the result both of a nominal prevent reallocation into tradables are more pervasive and exchange rate appreciation and of faster domestic than operate mostly through the extensive margin: new exporting international inflation (Figure 3.1, right panel). 21 firms, new markets or new products. Figure 3.1: Real and nominal effective exchange rate in Pakistan. Source: Bruegel and World Development Indicators. Note: Increases are appreciations (real and nominal). 20_Freund and Pierola 2012. 21_Rodrik 2008. 22_The effect of exchange rate movement on exports takes time to materialize. Seventy percent of the effect takes place within the first year. The adjustment is slower for merchandise exports, for which 55 percent of the effect takes place within the first year of the appreciation, than for services, for which the whole effect materializes within the first year. 25 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS The real appreciation of Pakistan’s currency evidence: the impact of real exchange variations is reduced contributed to reduced export competitiveness. Over for firms that import more intermediate inputs, and increased the period 1998-2016, real appreciations of 10 percent were for firms that add more value domestically. associated with contractions in Pakistan’s exports of 5.7 percent, all else equal. Merchandise exports are generally International experience suggests that a key slightly less elastic to changes in the RER compared to services determinant for success of export-led growth exports: a 10 percent appreciation decreased merchandise strategies has been preserving competitive exchange exports by 5.5 percent. In services, the same appreciation was rates. The experience of Chile during the structural reforms associated with a contraction of exports of 6.5 percent. of the 1970s and 1980s, and the more recent case of China, are paradigmatic examples of the importance of competitive The negative effect of Pakistan’s real exchange currencies for export performance. In Pakistan, allowing rate appreciation on exports was greater for export the currency to respond to market forces will likely lead to industries with higher shares of domestic value added. a depreciation in the short run, which could be useful for Shifting the focus of analysis from the macro to the industry closing the external imbalance at a macro level through the level reveals that real appreciation hurt competitiveness the micro channel of boosting firms’ export competitiveness. Such most for products with high shares of domestic value added, a depreciation would have the largest effect on firms with where exchange rates had an effect. In contrast, industries higher domestic value added. that relied more intensively on imported intermediates tended to be relatively insulated from real exchange rate appreciations. For example, a 10 percent appreciation in the Trade policy and integration RER reduced exports by 10, 11 and 9 percent in wood, textiles and clothing, and footwear, respectively; while it had no Pakistan’s trade policy has reverted to protectionism, significant effect on exports of transport equipment, which discretion and complexity over the past decade. The contain intermediate imports. This is in line with international country embarked on a major trade liberalization program Figure 3.2: Simple average tariff, Pakistan compared to South Asia and East Asia & Pacific, 2006–16. Source: World Integrated Trade Solutions Dataset. 26 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS in the mid-1990s, which resulted in reduced trade tariffs, to a point where they can compete globally. However, this simplification of the overall tariff structure, and abolition of approach also raises the specter of inefficient allocation of most quantitative restrictions and nontariff barriers. However, resources and of policy capture by dominant groups to further gains made in the 1990s and early 2000s have been gradually vested interests. Pakistan has one of the highest weighted losing ground to import substitution policies that have average tariff rate differentials in the region and the world discouraged exports. The number of statutory customs duty (Figure 3.3). Its weighted average tariff differential between rates doubled from four (5, 10, 15 and 25 percent) to eight (0, consumer goods and raw materials was 10.39 percent in 2016, 5, 10, 15, 20, 25, 30 and 35 percent) between FY2004/05 and reflecting a decrease of 2.93 percent over the past five years. FY2012/13, leading to higher tariff dispersion. Pakistan is currently By comparison, South Asia had a tariff differential of 8.17 the world’s seventh most protected economy, as measured percent between consumer goods and raw materials in 2016; 23 by the Overall Trade Restrictiveness Index (OTRI). Pakistan’s and East Asia, one of the most outward-oriented regions in tariffs are almost twice as high as the world average and three the world, and an active participant in GVCs, had a weighted times higher than those in East Asia and the Pacific (EAP). Tariff average tariff rate differential of only 1.03 percent. rates in Pakistan are also higher than other countries in South Asia. Pakistan’s simple average tariff rate was 12.55 percent in The complexity of Pakistan’s tariff structure has been 2016, compared to an average of 11.16 percent in the South Asia driven primarily by attempts to protect incumbent region (Figure 3.2). firms and in some cases to raise revenues. Different instruments, such as Additional Duties (AD), Regulatory Tariff escalation has been used as a tool to both Duties (RD) and Special Regulatory Orders (SROs), over which protect domestic firms and generate revenues. Tariff the Government has discretionary control, shelter incumbent escalation, measured as the difference in average customs firms from competition, and could even shape the way in duties paid on products at different stages of production which new firms enter some sectors. In addition, of the (primary, intermediate, consumer/final) is used in most roughly 7,000 tariff lines in Pakistan, about 4,000 are subject countries to enable local industries and firms to mature to various SROs, which reduce or exempt customs duties on Figure 3.3: Weighted average tariff by category, 2016. Source: World Integrated Trade Solutions Dataset. 20_The OTRI quantifies the uniform tariff that, if imposed on imports instead of the existing heterogeneous structure of protection, would leave aggregate imports at their current level. 27 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS intermediate inputs and raw materials used by exporters duty and tax remission for export (DTRE) program in Pakistan in selected industries or firms. On most other tariff lines, provides for post-export remission of duties and taxes on however, ADs and RDs are levied on top of the statutory inputs, the program has not been effectively implemented. customs duty, sometimes with the objective of raising Moreover, it can take two to four months for these fibers revenues, adding further complexity to the tariff regime. to be imported, which imposes delays and uncertainties in RDs were first introduced to address the severe balance- production that are not acceptable to global buyers. As a of-payments crisis during the global financial crisis of 2008, result, the Pakistani apparel industry is dominated by the and were meant to curb the import and consumption of production of low-value, cotton-based garments, using 24 “luxuries” while at the same time increasing revenues and poor-quality textiles sourced domestically. helping to manage the fiscal deficit. RDs were initially set in August 2008 for 374 tariff lines and later rationalized High protection also decreases the incentives to by SRO 482(I) 2009, which kept RDs for only 64 tariff lines export of firms in other sectors, such as the auto in several sectors, including agricultural products, ceramic sector (including motorcycles), which could play an and tile products, automobiles and guns, among others. important role in enhancing trade. Pakistan’s auto Multiple amendments have added – but rarely eliminated – industry is its sixth-largest manufacturing subsector and is tariff lines over the years. In 2014, SRO 568(I) 2014 instituted a key contributor to jobs and economic growth. Although RDs on an additional 400 tariffs lines – the largest increase the production of passenger cars has been stagnant since 2008. In October 2017, the eight SROs that had since 2006, motorcycle production has increased tenfold 25 previously imposed RDs on imports were consolidated into since 2001, reaching 2 million units in 2014. Pakistan is SRO 1035(I) 2017, and this further increased the number of one of the world’s largest manufacturers of motorcycles by tariff lines under RDs. SRO 1035(1) was superseded a few production volume. Despite a thriving auto sector, however, months later by SRO 640(I)2018, which increased RD levels key players in the sector choose not to reach out to export on various items by 2 to 10 percent. markets, where competition is tough, and focus instead on domestic markets, where high import tariffs mean high Pakistan’s protectionist trade policy has left its protection against efficient international auto makers. export sector at a steep disadvantage relative to its competitors. High tariffs on imported inputs for Despite Government efforts in recent years to exports, and high tariff rate differentials among primary, simplify and streamline its trade policy, they intermediate and consumer goods, have led to rising are still far from regional efforts linked to trade production costs and eroded production profit margins. development and promotion. Pakistan’s simple average Reliance on tariffs as a tool for revenue generation, tariff rate declined by 2.31 percentage points between especially when imposed on high-value capital goods, may 2006 and 2016, from 14.86 to 12.55. By comparison, South prevent local export-oriented industries from importing Asia’s simple average tariff over the same period declined efficiency- and productivity-enhancing equipment to lower by 3.28 percent, from 14.44 to 11.16; and East Asia’s average production costs. tariff declined by 0.94 percent, from 6.04 percent in 2006 to 5.1 percent in 2016. The simple average tariff also masks Textiles is one example of a key export sector in the realities of Pakistan’s tariff structure and its evolution which high tariffs are coupled with an ineffective over the past decade. Pakistan’s weighted average tariff, duty drawback mechanism. Most man-made fibers are after an initial drop in 2008, has largely remained stagnant subject to import duties of 10 to 25 percent. Although the at 10.1 percent (Figure 3.4). 24_Lopez-Acevedo and Robertson 2016. 25_Bari et al. 2016. 28 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Figure 3.4: Pakistan’s weighted average tariff, 2006–16. Source: World Integrated Trade Solutions Database. Pakistan’s high tariffs and complex regime relative goods was 10.41 percent in 2016, while both Vietnam and to its competitors still constitute an anti-export Malaysia had average tariffs on capital goods of 3.3 percent. bias. While peers have expanded their export base through trade policy reforms geared toward enhancing export The number, average level and dispersion of custom competitiveness, Pakistan had a simple average tariff of duty rates are decreasing, but not as fast as needed 10.19 percent on intermediate goods in 2016; this was 6.26 to better integrate into the global marketplace. percentage points higher than Vietnam’s, which stood at Changes to the tariff schedule introduced in the FY2014/15 3.93 percent in 2016, and 4.47 percentage points higher and FY2015/16 budgets brought the number of standard than Malaysia’s, at 5.72 percent in 2016. Similarly, Pakistan’s tariff slabs to five (2, 5, 10, 15 and 20 percent). Duties on 341 tariff rate on consumer goods was 16.72 percent in 2016, 5.23 tariff lines were reduced from 30 to 25 percent in FY2014/15 percent higher than the same tariff rate in Vietnam and 8.81 (eliminating the 30 percent tariff); and duties on 1,454 tariff percent higher than in Malaysia. Pakistan has consistently lines were reduced from 25 to 20 percent in FY2015/16. As a applied higher tariffs on the import of capital goods than result, between FY2012/13 and FY2015/16, the simple average these countries. Pakistan’s simple average tariff on capital tariff, the standard deviation, and the coefficient of variation Table 3.1: Evolution of regulatory duties in Pakistan, FY2012/13–FY16/17. Number of tariff lines % total imports RDs revenue as % of paying RDs paying RDs paid customs duties FY 12/13 134 0.4 1.9 FY 13/14 246 0.5 1.9 FY 14/15 572 8.5 9.3 FY 15/16 1,101 11.6 15.6 FY 16/17 1,166 12.6 17.1 Source: World Bank staff calculations based on customs data from the Federal Board of Revenue. 29 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS (a measure of dispersion of the tariff structure) declined from imports, there was a sharp increase in the use of other 14.4 to 13.4 percent, from 11.7 to 10.7 percent, and from 0.81 to exemptions – mainly those granted under the Fifth Schedule 26 0.80 percent, respectively. to the Customs Act – from 3 to 31 percent of total imports. However, the evidence suggests that the elimination of During the same period, however, the importance of these industry-specific SROs was not effective, since most Regulatory Duties increased (Table 3.1). The number of of the exemptions have been retained in the Fifth Schedule tariff lines affected by RDs jumped from 134 to 1,166 between of the Customs Act. FY2012/13 and FY2016/17, which resulted in a sharp increase in the percentage of total imports paying RDs (from 0.4 to As a result, the value of customs duty exemptions 12.6 percent). Regulatory duties now account for 17.1 percent has increased both in nominal terms and as a of customs revenues. percentage of imports. The total value of customs duty exemptions has increased from PR 142 billion (US$1.46 The use of customs duty exemptions also became billion) to PR 257 billion (US$2.47 billion), while the annualized more prevalent between FY2012/13 and FY2016/17. growth rate of customs duty exemptions (16 percent) Despite efforts to reduce tariff exemptions by eliminating outpaced the growth rate of total imports (5.2 percent) by some SROs, the percentage of imports that claimed a large margin between FY2012/13 and FY2016/17. Although exemptions from customs duties increased from 34 to the value of exemptions under free trade agreement or 50 percent of total import values between FY2012/13 and preferential trade arrangements grew by 16 percent during FY2016/17 (Figure 3.5). While the use of industry-specific this period, they still account for less than a fifth of total SRO exemptions decreased from 22 to 5 percent of total exemptions (Figure 3.6). Figure 3.5: Import value under exemptions from customs duties as percentage of total imports. Panel A FY2012/13 Panel B FY2016/17 Source: World Bank staff calculations based on customs data from Federal Board of Revenue (FBR). 26_Under the Rationalization Plan, the Government agreed to eliminate industry-specific SROs – starting with SRO 567(I)2006 and SRO 575(I)2006 – but to keep exemptions for some products and industries deemed “socially sensitive” and incorporate those into to the Fifth Schedule to the Customs Act. 30 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Figure 3.6: Value of customs duty exemptions (PR billions). Source: World Bank staff elaboration using customs data from Federal Board of Revenue (FBR). While duty exemptions reduce the effective customs smaller exporters are less likely to import. Only 19.2 percent of duty paid by exporters, they do not benefit all firms, micro-exporters and 31.5 percent of small exporters imported and their impact is skewed toward larger firms. Exporters goods and services, compared to 84.1 percent of large firms in need to import their own intermediate inputs in order to benefit FY2016. Larger firms have also benefited the most from duty from the main customs duty exemptions, and fewer than one exemption schemes. Only five firms - the largest - accounted third of exporters (31 percent) did so in FY2016. Furthermore, for 28.6 percent of that total (Figure 3.7). Figure 3.7: Percentage of duty exemptions claimed by top 250 firms. Source: World Bank staff calculations based on customs data from Federal Board of Revenue (FBR). 31 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS International experience shows that imported Pakistan jointly account for 92 percent of South Asia’s inputs are key for the competitiveness of exporters GDP. As of 2014, India-Pakistan trade accounted for only 6 in developing countries. Imported inputs, particularly percent of total intraregional trade. Trade restrictiveness intermediate inputs, are generally of higher quality, and between India and Pakistan is primarily the result of embody technology and knowledge that lead to higher nontariff barriers that have been deployed by the two firm productivity and improved quality of final products. countries to prevent access to their respective markets. Therefore, the ability to source inputs at competitive Removal of these barriers and a normalization of trade ties prices irrespective of origin could help Pakistani firms between the two countries has the potential to ramp up 27 become more competitive in international markets. trade from its current level of US$2.5 billion a year to as 28 Greater use and variety of imported intermediary inputs much as US$42 billion. is also correlated with higher exports and diversification of destination markets. Yet only about a third of Pakistani Pakistan has not fully taken advantage of its exporters directly import some of their inputs. proximity to China, a trade powerhouse, with which it has a free trade agreement. Partial equilibrium In Pakistan, users of imported inputs are analysis shows that the FTA has had only a modest impact outstanding performers. We used firm-level data for on Pakistan–China trade. Over the past seven years, only FY2014/15 and FY2015/16 to analyze the impact of greater 4.6 percent of the total increase in imports from China – numbers and varieties of imported inputs on their export imports increased by 68 percent overall – is attributable 29 performance. The results reveal significantly higher export to the FTA. Similarly, only 3.6 percent of the increase values and a larger number of destinations than average in exports to China, mainly cotton yarn and woven fabric, for exporters that import more products and more varieties bed linen, leather, marble and surgical instruments can (defined as product/origin combinations). For example, firms be attributed to the FTA. Key Pakistani exports remain at that directly import intermediate inputs have 5 percent no or partial concessions under the FTA. While China has larger export values and export their products to 18 percent granted concessions on tariff lines amounting to 83 percent more destinations, on average, than firms that do not of export volume, about 70 percent of exports are in tariff import those inputs directly. These estimates provide some lines at less than 50 percent or no concession. These evidence that the foreign technology embodied in imported results suggest that Pakistan needs to actively renegotiate intermediate inputs has a beneficial effect on exporter key aspects of the FTA with China. performance in Pakistan. Pakistan’s inability to reform its trade policy over the Restrictions to regional trade make it difficult years and realign its focus toward building export for Pakistan and other South Asian countries competitiveness can be attributed to institutional to leverage the region as a platform for export fragmentation within the Government. Key policy- growth and regional integration. Intraregional trade level decisions linked to trade are the domain of multiple accounted for only 7.7 percent of total trade in South Asia government agencies, including the Ministry of Commerce, in 2014, compared to 31 percent in East Asia, a region the Federal Board of Revenue and the Ministry of Finance. with approximately the same population. Pakistan, in Moreover, policy decisions regarding exchange rate, taxes particular, has not been able to fully leverage the potential and refunds are currently driven by fiscal considerations. This of its location. The gravity model indicates that Pakistan partially explains the Government’s insistence on maintaining is undertrading with India, despite the fact that India and high tariffs. Difficulties in implementing a coherent trade 27_Successful examples of the impact of tariff liberalization on trade and productivity come from Indonesia and Chile. In the first case, manufacturing census data from 1991-2001 showed that a 10 percent fall in tariffs led to a productivity gain of 12 percent by firms that imported their inputs (Amiti and Konings 2007). In the case of Chile, the productivity of firms in import-competing goods sectors improved, on average, 3 to 10 percent more than the productivity of plants in the nontraded-goods sectors due to liberalized trade (Pavcnik 2004). 28_Alternative measures of trade potentials between India and Pakistan exist. De and Ghani 2013 provides a discussion on some of the underlying analyses. 29_Ferrantino and Rehman, Forthcoming. 32 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS policy are also evident in the delays in refunding tax and cost, time and steps to start a business, highlights duty drawbacks for goods and services. Pending sales tax the increasing competitive disadvantage of refunds topped PR200 billion (US$1.6 billion) in November 2017, Pakistani businesses (Figure 3.8). It takes 17.5 days to creating liquidity constraints for exporters. start a business in Pakistan, compared to the South Asian average of 15.4 days and the OECD country average of 8.5 days. Similarly, it takes 12 steps to start a business in Investment climate and Pakistan compared to 8 for South Asia and 5 for OECD foreign direct investment countries. Moreover, the frequency of tax payments for limited liability companies in Pakistan has remained at 47 Investment climate constraints also continue to per year over the past decade, significantly higher than impede trade and competitiveness in Pakistan. the South Asian average of 30 and the OECD country Pakistan ranked 147th out of 190 economies in the Doing average of 12. Preparing and paying for these taxes takes Business Report 2018, lower by 71 places since 2008. The an average of 312 hours a year in Pakistan, compared to World Economic Forum’s annual Global Competitiveness 277 hours in the South Asian region. It costs 1,664 percent Report of 2018 also points to Pakistan’s diminished of Pakistan’s income per capita to obtain an electricity competitiveness over the last decade: its ranking on the connection, compared the South Asian average of 1,163 Global Competitiveness Index dropped from 92nd in 2008 to percent. Electricity is therefore out of reach for many of 115th in 2018. Pakistan’s micro, small, and medium-sized enterprises. The cost of obtaining an electricity connection for business An increasing cost of doing business in Pakistan, establishments is approximately 26 times higher in as measured along the three core dimensions of Pakistan than in OECD countries. Figure 3.8: Time required to accomplish selected doing business tasks. Source: World Bank Doing Business Report. 33 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Pakistan’s worsening performance on indexes to 0.91 percent of GDP, comparable to Bangladesh at 0.88 and measuring the overall investment climate is reflective considerably lower than Vietnam at 6.31 percent in the same 31 of these barriers. Partly as a result of its inadequate year. One reason for Pakistan’s difficulty in attracting long- investment climate, private investment, accounting for two- term FDI is its security environment, which drives up the risk thirds of total investment in Pakistan, remains low at around 10 premium and deters risk-averse investors. percent of GDP. On the other hand, public investment remains at 5 percent, on the back of low fiscal space. Overall, with Moreover, the foreign investment that Pakistan does investment as a share of GDP of around 15 percent, Pakistan attract has been directed toward less sophisticated contrasts with the average for South Asia at almost 30 percent. sectors. FDI in advanced sectors is critical for gains in diversification and productivity. In Pakistan, however, the Of particular relevance for trade competitiveness is majority of FDI is directed towards sectors with low levels of that Pakistan has been unable to attract meaningful sophistication (Figure 3.10). In the services sector, the share long-term and stable foreign direct investment. FDI in of FDI directed towards less sophisticated (“low knowledge developing economies reached a high of US$671 billion in 2017, intensity”) services increased from 10.7 percent in 2005 to 62.6 32 16 percent above the 2008 level. Developing Asia, with FDI of in 2015, due to a decline in FDI in knowledge-intensive sectors. nearly half a trillion dollars, remained the largest recipient of In the goods sector, the share of FDI directed towards less 30 FDI in the world. Pakistan, however, has not been able to sophisticated (“resource based” and “low-technology”) products capitalize on international investors’ appetite for high-return rose from 60.5 percent in 2005 to 93.9 percent in 2015. Deeper investments in developing countries. While other countries integration with the Chinese economy, through increased in the region have used FDI as seed capital to support high- bilateral trade and investment and participation in Chinese- potential and high-growth industries within their export led global value chains, could be an important channel for sector, Pakistan has failed to draw meaningful long-term FDI accelerating growth in Pakistan. The current implementation to revitalize its exports (Figure 3.9). Foreign direct investment of China-Pakistan Economic Corridor (CPEC) is leading to an has also been more volatile compared to other countries in the increase in FDI flows from China to Pakistan, which have thus region. Pakistan drew US$2.8 billion of FDI in 2017, equivalent far been concentrated in energy and infrastructure. Figure 3.9: FDI inflows as percentage of GDP, Pakistan compared to South Asia. Source: World Development Indicators, World Bank. 30_UNCTAD. 31_It is worth mentioning that a substantial portion of FDI to Pakistan has public guarantees or guaranteed purchase prices (e.g.: in energy projects). 32_International evidence suggests that FDI is a powerful vehicle for technology transfer. When multinational firms set shop in a host economy, they usually bring with them sophisticated managerial practices, top-class technologies and organizational processes. These elements usually spill over to the domestic economy through multiple channels, including competition with domestic firms that incentivizes domestic firms to innovate and imitate; training of labor, whose skills then circulate around the economy; and supplier-client interactions, which promote learning. Evidence also suggests that these spillovers are greater when more knowledge is embedded in the core activities of the multinationals. This is why FDI in sophisticated, knowledge-intensive activities is more likely to be associated with domestic upgrading. 34 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Figure 3.10: Share of announced FDI inflows by technology level. Goods Services Source: FDI Markets and World Bank staff calculations. Note: Refers only to press announcements. Services trade policy In Pakistan, domestic regulations affect key trade- related services, as reflected in the World Bank’s Openness to trade in services is strongly associated Services Trade Restrictiveness Index (STRI). The STRI with openness to FDI, and matters crucially for database collects information on applied services trade productivity growth. Trade in services allows for the exchange policies across 103 countries, 18 services sectors (covering of technical know-how, technological diffusion, and integration telecommunications, finance, transportation, retail and into global value chains, which, if encouraged, can enable firms to professional services), and key modes of service supply. The 33 enhance productivity and competitiveness. Barriers to trade in STRI shows that Pakistan exports and imports services to a services in the form of cumbersome regulations have the effect much lower degree in per capita terms than most peers with of deterring both imports and exports of services. an equal level of trade restrictions (Figure 3.11). Figure 3.11: Pakistan exports less services than expected for its level of trade restrictiveness Relationship between STRI and Imports and Exports, 2009. Panel A Panel B Sources: World Bank STRI; World Development Indicators. 33_Indeed, some services can only be traded through the commercial presence of a foreign company in the host economy (e.g., a bank opening a physical branch or an internet service provider offering internet in another country, which trade economists call “mode 3” of services trade), making trade and investment two sides of the same coin. 35 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Regulatory restrictions to services trade prevail in services on a timely basis and with lower transaction costs. crucial areas for trade integration. While regulatory Logistics costs, both monetary costs and costs associated restrictions in Pakistan’s services sector compare relatively with processing times, despite having fallen overall and favorably with other countries at a similar per capita GDP over time, are still considerably higher in Pakistan than in and are lower than might be expected based on its level of peer group comparators and the region (Figure 3.13). The development (Figure 3.12), those restrictions are relatively typical container dwell time at ports in Karachi (95 percent of high in areas most important for trade integration – insurance Pakistan’s international trade goes through one of the two and financial services, professional services, and transport ports in Karachi) is seven days, three times longer than that of services. Both insurance and financial services are heavily developed countries and East Asia. restricted, making it very difficult for foreign providers to establish affiliates in Pakistan to sell their services. Poor levels of trade facilitation and logistics services Professional services are relatively liberal through cross- leave Pakistan at a steep competitive disadvantage border trade, but Pakistan still upholds significant restrictions relative to regional competitors. As of 2017, border and on establishing a physical presence. documentary compliance to export from Karachi takes 130 hours, compared to 12 hours in OECD countries. Similarly, border and documentary compliance to import takes 272 Trade facilitation hours, compared to 11 hours in OECD countries. Despite recent improvements in logistics, poor levels Pakistan has initiated a series of reforms over the of trade facilitation and infrastructure continue to past decade to upgrade its trade facilitation and inhibit export competitiveness and trade growth logistical policies and infrastructure. However, reforms in Pakistan. Reducing trade costs, upgrading service carried out by the Government in logistics, customs, timelines, quality, and improving connectivity between domestic and infrastructure, and tracking and tracing (Figure 3.14) have not foreign markets can play a decisive role in increasing export yet resulted in the necessary level of improvements on the competitiveness by allowing countries to trade goods and ground. Figure 3.12: SPakistan’s service sector face lower restriction that similarly placed countries STRI and Development and Value Added in Services as Part of GDP, 2013. Panel A Panel B Sources: World Bank STRI; World Development Indicators. 36 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Figure 3.13: Cost to export and documents required to export, Pakistan and peers. Panel A Panel B Cost to Import (US$ per Container) Documents required to export (2014) Source: Doing Business Indicators, World Bank. That is why the Logistics Performance Index (LPI) process (speed, simplicity, predictability of formalities) by shows a drop in Pakistan’s performance over time. border control agencies has dropped from 134th in 2010 to Pakistan’s ranking on the LPI has fallen from 110th in 2010 to 139th in 2018. Its ranking on the timeliness indicator, which 34 122nd in 2018 (Table 3.2). Given this decline from a very low measures whether shipments reach their destination within base, Pakistan’s poor logistics performance continues to be the scheduled or expected delivery time, dropped from 110th a constraint for trade, and in particular for integration into in 2010 to 136th in 2018. Pakistan’s ranking on the logistics global value chains. A key aspect of participation in GVCs infrastructure indicator, which measures the quality of trade- is the ability to import to export. This requires, as a starting and transport-related infrastructure (including ports, railroads, point, logistics and transit times that are fast, reliable and roads and information technology), also fell slightly, from 120th predictable. Pakistan’s ranking on efficiency of the clearance to 121st during 2010-18 (Figure 3.14). Figure 3.14: Pakistan’s logistics performance has not improved across most categories. Logistics Performance Indicators, 2018 compared to 2010. Source: World Bank Logistics Performance Index. 34_The LPI, based on 160 countries, is benchmarking tool created to help countries identify challenges and opportunities in their performance on trade logistics. 37 3.DRIVERS OF PAKISTAN’S TRADE AND INVESTMENT COMPETITIVENESS Table 3.2: Logistics Performance Index (LPI), 2010 and 2018. 2010 2018 Country LPI Score Global Rank LPI Score Global Rank Bangladesh 2.74 79 2.58 100 India 3.12 47 3.18 44 Sri Lanka 2.29 137 2.6 94 China 3.49 27 3.61 26 Pakistan 2.53 110 2.42 122 Vietnam 2.96 53 3.27 39 Malaysia 3.44 29 3.22 41 Thailand 3.29 35 3.41 32 High Income 3.66 3.67 South Asia 2.21 2.51 Source: World Bank Logistics Performance Index. To ensure that Pakistan’s performance improves sector, beyond just an improved “ranking.” Currently, Pakistan’s relative to regional and international champions in logistics performance is worse than India’s and the East Asian trade and logistics, reforms need to be more targeted, and global averages, although better than the South Asian sustained, and synchronized with other trade policy average. Pakistan’s ranking on the customs performance reforms. It is imperative that the Government reflect on indicator is 47 places lower than India’s and 56 places lower than progress in comparison with other countries and regions and Vietnam’s. Similarly, Pakistan’s ranking on the infrastructure pursue reforms that result in tangible results for the private indicator is 69 places lower than India’s (Figure 3.15). Figure 3.15: Pakistan’s logistics performance is worse than India and Vietnam. Logistics Performance Index 2018 - Comparison with Peer Group. Source: World Bank Logistics Performance Index. 38 39 4.WHAT WOULD IT TAKE TO MOVE PAKISTAN’S TRADE POLICY FORWARD? Improving trade competitiveness is a long-term investment competitiveness. The section also summarizes undertaking, and the full realization of Pakistan’s the main constraints to export competitiveness identified in export potential can only be achieved if trade policy consultations with large and small exporters (Box 4.1). reforms are implemented along with complementary reforms aimed at improving firms’ productivity and capabilities. The reforms proposed in this note should not Streamline tariffs and be taken in isolation, but need to be accompanied by efforts eliminate para-tariffs to improve the domestic business environment, including privatization of inefficient state-owned enterprises, removal 1. Prepare and implement a roadmap for tariff reform of energy bottlenecks, and simplification and transparency of under the leadership of the Minister of Commerce and tax laws. Policies should also focus on reforming institutions, under the guidance of an inter-ministerial committee on developing financial markets, increasing technological trade policy. One of the arguments against streamlining the readiness and market size, and facilitating business import regime is the dependence of fiscal revenue on customs sophistication to encourage entrepreneurial activity and duties. However, FBR data show that Pakistan’s fiscal revenue increased investment in the country. is much less dependent on customs duties than in the past; in 2017, customs duties amounted to 10.4 percent of total revenue, This section presents a series of recommended substantially down from 17.8 percent in 2005 (Table 4.1). actions in several areas related to trade. These include trade policy, trade facilitation, connectivity, investment climate, The first step would be to form an inter-ministerial and institutional coordination which the Government could task force for tariff reform made up of the secretaries of undertake to stimulate growth through increased trade and key departments of the Ministry of Finance, the Ministry of BOX 4.1. LEARNING FROM PRIVATE SECTOR CONSULTATIONS The World Bank Group conducted a series of consultations and roundtables with private sector stakeholders, with the aim of identifying constraints to improving export competitiveness. The findings helped to inform this note and will also feed into the Government’s preparation of the Strategic Trade Policy Framework (2018-23). The events were organized across Islamabad, Peshawar, Karachi and Lahore between September and November 2017. There were 254 participants, including current, past and potential Pakistani exporters in the manufacturing, agro- processing and services sectors. Seventy-two percent represented SMEs while the rest represented larger entities. The key objective of the consultations was to solicit participants’ views about issues affecting export competitiveness, including regulatory, policy, infrastructure and knowledge gaps. The following main challenges were identified: a. regulatory constraints at the federal and provincial government levels b. high cost of doing business, including energy costs and import tariffs c. inadequate trade facilitation and supporting instruments d. lack of coordinated support from institutions responsible for export promotion, including lack of assistance with market and product diversification e. lack of access to credit for exports, particularly for new and potential exporters f. an exchange rate regime that reinforces the anti-export bias of trade policy. 40 4.WHAT WOULD IT TAKE TO MOVE PAKISTAN’S TRADE POLICY FORWARD? Table 4.1: Reliance of revenue on customs duties has dropped since 2004-05. Revenue from Customs Duties, Millions PRs, 2004/05-2016/17 Revenue Source 2004/05 2009/10 2012/13 2013/14 2014/15 2015/2016 2016/2017 Customs duties 117,000 161,489 239,608 240,997 306,000 348,500 491,054 Tax revenue 659,000 1,500,000 2,199,232 2,564,509 3,026,000 3,419,795 3,825,235 Total revenue* 900,000 2,079,000 2,982,436 3,637,297 3,937,000 4,332,616 4,737,354 Customs/revenue 17.8 7.8 8.0 6.6 7.7 8.1 10.4 Customs/taxes 13 10.8 10.9 9.4 10.1 10.2 12.8 Source: World Bank staff calculations based on Federal Board of Revenue data. Note: *Excluding grants. Commerce, the Federal Board of Revenue and the Board of discourage producers from investing in quality upgrading, 36 Investment. Such a task force should enable the consistency which makes them less competitive in international markets. and coherence of trade policy by: A move towards correcting these distortions would require • Striking an explicit balance between short-term fiscal approval of the tariff reform proposed in the Strategic Trade needs (revenue collection) and longer-term export and Policy Framework (2018-2023). economic growth; • Ensuring the elimination of unnecessary regulatory 3. Tackle the issue of para-tariffs (such as regulatory barriers to trade; duties), not just SROs. Selective protection and concessions • Providing guidance on long-term competitiveness so on inputs for low-productivity sectors remain a source of that key economic sectors such as auto, pharmaceuticals, inefficiency, since resources are diverted away from industries and textiles, which currently enjoy relatively high levels of that have higher export potential. A simple and transparent protection, are subject to international competition within a import regime that benefits the export sectors will require not medium-term horizon. only streamlining the tariff system, but also setting clear and • Ensuring that potential exports are not constrained by transparent rules and lock-in clauses for the exceptions and for the lack of quality imports at world prices. regulatory duties. Actions to accomplish this goal include: • Streamlining the use of regulatory duties, and 2. Commit to a simple and transparent tariff structure eliminating temporary regulatory duties that are trade with low average tariffs and minimum dispersion. impeding; Transparency, simplicity and durability of trade policy reform • Ending the practice of adding regulatory duties to are essential to create a level playing field and to minimize additional tariff lines; trade costs in general and export costs in particular. Domestic • Increasing transparency and streamlining the use of market protection through import tariffs generates an anti- exemptions through: export bias, leading domestic firms to prefer to serve the Publication of the full list of tariff lines that can be sheltered domestic market rather than venture into export subject to an exemption, and explaining the reasons markets, where they face tougher competition and do not for any new exemptions; 35 enjoy any price advantage. This situation reduces incentives Implementation of a well-functioning duty drawback for firms to innovate and upgrade their productivity levels. scheme for firms that import intermediates and raw In addition, high rates of protection in intermediate inputs materials for further processing. 35_Reis et al. 2011 36_Examples of tariff liberalization that have been successful include Chile and Sri Lanka. During the 1974 to 1979 period, Chile implemented a large trade liberalization program. The country eliminated most of its nontariff barriers and reduced the tariff rates, many of which exceeded 100 percent in 1974, to a uniform 10 percent ad valorem tariff across industries in 1979 (Edwards 1994). Within the region, countries such as Sri Lanka have eliminated all import tariffs on textiles in order to improve competitiveness in the garment industry (World Bank 2017). 41 4.WHAT WOULD IT TAKE TO MOVE PAKISTAN’S TRADE POLICY FORWARD? Improve trade facilitation revenue collected by Pakistan Customs. Pakistan currently has and connectivity more than 58,646 users of WeBOC, which operates 24/7The participation of every trade-related regulatory agency in the automated processing system is essential. Pakistan and other members of the World Trade Organization signed a Trade Facilitation Agreement 3. Continue working on the implementation a national (TFA) in 2013 that aims at streamlining trade single window (NSW) system to reduce trade costs procedures. The TFA sets forth a series of best practice 38 and improve connectivity. Specific actions could include: measures for moving goods across borders with maximum efficiency. Once the agreement is fully implemented by all • Ensuring that the National Trade Facilitation Committee is fully operational, in accordance with WTO Trade Facilitation signatories, it is expected to reduce total trade costs by Agreement Article 23.1; more than 14 percent for low-income countries and more than 13 percent for upper-middle-income countries. To benefit • Conducting a gap analysis in the current legislation and regulatory framework to enable implementation of the NSW; from this global agreement, Pakistan will need to expedite its ongoing work on connectivity infrastructure and trade • Drafting of an implementation plan for the NSW strategy; corridors. This will entail: • Launching the NSW and linking certificate-, license-, and permit-issuing agencies to the NSW. 1. Adoption of a modern, risk-based compliance management strategy supported by a robust enabling 4. Re-engineer the cargo clearance process for import, legislative framework, with simplified, transparent export and transit cargo at the main seaports, airports business practices and procedures. To achieve this and border crossing points. In its efforts to streamline objective, customs administrations around the world and simplify cargo clearance, it is paramount that Pakistan have increasingly adopted new approaches based on the Customs reforms clearance processes taking into account the principles of risk-based compliance, which improves facilitation current improvements in its automated tool WeBOC. and controls. In line with global efforts, Pakistan’s border regulatory agencies, including customs, must adopt a more modern, robust and well-defined risk management framework that encompasses both revenue control and border control Enhance the role and security. Such a framework will enable the allocation of of services in trade more resources toward higher-risk transactions (i.e., exports) while processing compliant consignments more efficiently. The following actions could help Pakistan increase its competitiveness; move up the value chain in the manufacturing 2. Completion and implementation of an automated and agricultural sectors (by capturing more value added in processing system for border management. Pakistan GVCs through the domestic sourcing of services); boost its Customs is striving to completely replace its old clearance attractiveness to investors; and promote services exports. system (“One Customs”) with the web-based customs software WeBOC, which provides a portal for filing and processing export- 1. Conduct a diagnostic to: and import-related documents. Such software should be • Assess the level of restrictiveness of domestic aligned with the World Customs Organization (WCO) data model. regulations (including restrictions to FDI), and propose Currently, 80 percent of all goods declarations are processed critical reforms in key backbone services such as through WeBOC; these declarations cover 83 percent of all transport, energy, logistics, and financial services; 37_The WCO Data Model is an initiative of the World Customs Organization to simplify and standardize data requirements of cross-border regulatory agencies including customs. 38_A project management unit (PMU) has already been setup. The Government has appointed FBR/Customs as the lead agency. Assessment of the need for a NSW has been done to some extent with support from USAID. 42 4.WHAT WOULD IT TAKE TO MOVE PAKISTAN’S TRADE POLICY FORWARD? • Assess the level of competition in key services Continue improving the sectors in order to address distortions that might main supply-side challenges harm the contestability and competitiveness of those affecting Pakistan services in the export market. The overall investment climate needs to be improved to 2. Engage in specific actions to improve services attract high-quality FDI. Actions include: exports development and of sophistication. a legal Efforts framework for could include e-commerce • Creating and enhancing existing high-priority economic zones, using public-private partnerships development, establishment of services knowledge where possible, to allow investors to access basic platforms (SKPs), and promotion of religious and ancestral industrial infrastructure and inputs at world prices and tourism services. operate in a secure environment while the rest of the 39 economy is catching up. A first step would be to 3. Modernize trade policy and the services regulatory assess the effectiveness of existing special economic framework, including in the areas of: zones in the country and to learn from the best • Cross-border trade in services; practices in other countries. • Strategic coordination between the Ministry of Trade • Addressing problems related to energy accessibility and other services regulatory institutions at the federal and costs and access to finance; enhancing skills, and provincial levels; including managerial skills; and enhancing the quality of • Data protection and consumer protection, particularly business regulations. in online transactions. • Consolidating all business regulations and bringing them into the public domain through an accessible 4. In the medium to long term, Pakistan should define platform; reviewing the regulations; and assessing their a national services export promotion strategy. In impact on business. formulating this strategy, the Government could: • Identify the sectors where opportunities exist for Pakistan, based on high-quality statistics and services Enhance macroeconomic trade data; stability by allowing greater • Formulate a strategy for negotiating with major exchange rate flexibility partners. This will require coordination among ministries and between the public and private sectors. Allowing greater exchange rate flexibility would improve • Identify ways to move up value chains and increase Pakistan’s macroeconomic stability, which would in turn the benefits of participation to GVCs. The first step help to improve competitiveness. Moving to a market-based would be to analyze the share of domestic services exchange rate would enable Pakistan to reduce the external embedded in the exports of specific sectors and imbalance in the short run, and in the long run, to have Pakistan’s positioning in GVCs; then identify missed a buffer to better weather external shocks. International opportunities for services supply, obstacles to local experience suggests that a key determinant of successful sourcing of services, and solutions to increasing the export-led growth strategies has been preserving competitive relative share of domestic services in goods exports. exchange rates. In Pakistan, between 2008 and 2017 the • Improve the coordination, consistency, and rupee appreciated by 32.3 percent in real terms, while the coherence of trade policy. appreciation accelerated during 2013-2016, at a rate of 6.2 39_A successful example of this approach is Bangladesh. To improve the competitiveness of its apparel industry, the Government developed bonded warehouses enabling rapid, duty-free imports of textiles for exporters (World Bank 2017). 43 4.WHAT WOULD IT TAKE TO MOVE PAKISTAN’S TRADE POLICY FORWARD? percent per year. Allowing the currency to depreciate could dispute resolution; boost firms’ export competitiveness, helping to close the Extend the APTTA to other countries in the external imbalance at the macro level. Such a depreciation region such as Tajikistan, in order to maximize its will most benefit firms with higher shares of domestic value benefits. added. • Conduct intensive ex-ante analysis on the expected impact of any proposed trade agreements. The Pakistan-China FTA serves as a Prepare the ground for cautionary note. While targeted tariff concessions on deeper integration into imports from China have resulted in an increase of regional and global markets value-added exports from Pakistan, Pakistan’s exports to China remain at no or partial concessions—about 1. Pakistan needs to fully leverage its proximity to 70 percent of exports are in tariff lines at less than 50 both regional and global trade leaders. Integration with percent or no concession. neighboring countries and regions is all the more important • Fully normalize trade relations with India to given the need for the country to diversify both its product facilitate trade integration. Integration is necessary basket and markets. To improve integration, Pakistan needs to: to benefit from India’s fast growth and promote • Make the Pakistan-Afghanistan Joint complementarities, including value chain activities Economic Commission (JEC) effective in order to and investment potential. Integration not only entails streamline implementation of bilateral economic ensuring market access, but also building upon signed cooperation reforms. The JEC should meet on a agreements regarding mutual recognition and visas; semi-annual basis with a predetermined agenda. It and improving infrastructure, institutions, services, should also invite members of the Pakistan Business policies, procedures, and market-oriented regulatory Council, the Pakistan–Afghanistan Joint Chamber of systems. Commerce and Industry, and consumer associations to 2. Prepare the ground for deeper integration. In the discuss important issues. The JEC should become the medium to long run, to better benefit from GVC participation, main forum to review the status of large-scale projects Pakistan should aim at signing agreements with greater that impact transit trade cooperation. depth. Empirical studies show that signing agreements that • Revise and fully implement the Afghanistan– go beyond market access and also address investment, Pakistan Transit Trade Agreement (APTTA) in light competition policy, services, movement of capital and of recent international and regional developments, and: intellectual property issues can help countries to better Enforce measures aimed at minimizing the integrate and upgrade in global value chains and attract more 40 incidence of customs fraud and avoidance, and FDI. Deeper forms of integration with China could magnify monitor and curb informal trade; the potential of CPEC by further promoting complementarities Fully incorporate the Convention on the between the two countries. For example, preliminary analysis International Transport of Goods in the revised on the trade effects of the Belt and Road Initiative suggests agreements. 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