Pakistan can earn at least $24 billion from just regional exports. Why has it been unable to do that?

Pakistan plans to increase its annual exports to $60 billion in five years. The biggest question on everyone’s mind — how?

The country’s exports in fiscal year 2023-24 (FY25) were half that figure. It is constantly in a trade deficit even with regional neighbors such as Sri Lanka.

Its economy, classified as lower-middle income, has faced persistent imbalances in external and fiscal accounts. The country’s Achilles’ heel is its vicious boom-and-bust cycle, exacerbating the trade imbalance because its exports depend on raw material imports.

But, that isn’t the extent of what ails its export industry.

Tariffs and anti-export bias

Pakistan’s National Tariff Policy for 2019-24 has failed to simplify the framework for boosting exports, resulting in a distorted tariff structure.

Pakistan faces tariffs ranging from 1% to 652% on goods exported to nine regional countries. More than 600 tariff lines across all 99 chapters are subject to an ad valorem tariff when exporting to Afghanistan and China as evident from the distribution of HS codes (at 8-10 digits) over tariff brackets.

According to the Federal Board of Revenue (FBR), the government agency responsible for administering and enforcing tax laws, Pakistan increased customs duties on imports of seven products from China, raising rates from 0% to between 3% and 11%, effective July 1, 2022.

According to an October 2023 report by the International Monetary Fund (IMF), Pakistan’s trade restrictions — including exchange measures, tariffs, non-tariff barriers, and payment restrictions — have consistently placed the country near the 90th percentile of the highest Aggregate Trade Restrictions index. This level of protection has likely hindered rather than improved Pakistan’s competitiveness.

Additionally, research by Nukta reveals that the World Economic Forum’s Global Competitiveness Index 4.0 ranks Pakistan lowest in trade tariff complexity at 139th, followed by India at 134th and Bangladesh at 130th.

Less sophisticated products

Another drawback is that Pakistan produces less sophisticated products. With a GDP of $338.37 billion in 2023, the country has consistently exported between $20 billion and $25 billion over the past decade. The United States is Pakistan’s top market, but its share remains modest, ranging from 0.12% to 0.13%.

The lack of competitiveness in global value chains (GVCs) has kept Pakistan from progressing in more advanced industries. The country’s export base relies heavily on low-tech manufactured goods and agricultural products, particularly raw rice, cotton, and low-quality textiles (excluding man-made fiber articles). This focus on less knowledge-intensive sectors has hindered Pakistan’s economic diversification and productivity growth.

The country faces considerable obstacles to reallocating resources into more complex industries. According to an IMF staff report from October, these obstacles include microeconomic distortions such as public procurement of agricultural goods, price controls on raw materials, and financial incentives that favor low-productivity sectors.

Separately, according to a report from Harvard’s Growth Lab, Pakistan has developed only 21 new items since 2005. However, its per capita income has increased by only $2. This lack of economic complexity has contributed to the country’s stagnant export profile, limiting its ability to participate in higher-value industries.

Dr Aadil Nakhoda, an assistant professor of economics at the Institute of Business Administration (IBA), told Nukta that Pakistan’s trade focuses more on forward linkages — selling goods to other countries — rather than backward linkages, which involve adding value to raw materials before exporting them. This dynamic means that while Pakistan’s trading partners engage in more sophisticated activities, the country continues to rely on lower-value exports of repetitive products.

Pakistan’s position in global trade is further challenged by its regional trade restrictions, which limit access to markets and discourage the development of more complex export goods.

According to the Observatory of Economic Complexity, as of 2022, the country ranked 85th in the Economic Complexity Index, the same ranking it held in 2000. Pakistan ranks significantly behind its regional counterparts in the ECI.

Political turmoil

South Asia remains the world’s least connected region due to political rivalries and diplomatic tensions between Pakistan and India, which have damaged bilateral trade and rendered the South Asian Free Trade Area ineffective.

The trade relationship between the two nations was last normalized between 2014 and 2018, but the government suspended all bilateral trade with India in 2019 due to escalating political tensions over the Kashmir issue.

“There is hardly any trade between Pakistan and India, while trade with other countries is again mostly limited to basic commodities and raw materials,” Nakhoda highlighted.

The World Bank estimates that trade between the two countries could increase by an extraordinary 80% — amounting to approximately $25 billion — if relations improve in the near future.

A stronger relationship would also boost reserves, as Pakistan would no longer rely on third countries like the UAE for trade with India, thereby reducing freight and re-routing costs by around $1 billion each year.

Connectivity issues, smuggling, and security

Given Pakistan’s advantageous position and facilities, transit trade offers the country tremendous potential for further economic growth. Landlocked nations such as Afghanistan and the Central Asian Republics can easily access international markets through Pakistan’s ports because of its strategic location at the crossroads of Central Asia, the Middle East, and South Asia.

However, trade is somewhat restricted due to poor connectivity, border skirmishes, smuggling issues, the closure of key border crossing points, strict policy measures, and security concerns. Frequent border security issues with Afghanistan disrupt trade flows, resulting in a decline in transit trade, with goods diverting to Iran.

The Afghanistan-Pakistan Transit Trade Agreement is currently dysfunctional due to a recent 10% trade tax imposed by the provincial Khyber Pakhtunkhwa government on Pakistan’s exports of confectioneries, footwear, machinery, blankets, homemade textile articles, and apparel to Afghanistan. Meanwhile, imports of tires, black tea, dry fruits, fabrics, cosmetics, vacuum flasks, and home appliances have been banned.

Additionally, inadequate infrastructure, such as underdeveloped transport and logistics networks, hinders efficient trade, especially with landlocked neighbors, leading to increased costs and delays, Dr Usama Ehsan, head of research at the Policy Research and Advisory Council, told Nukta.

Trade is also often hindered by limited formal banking channels with countries such as Afghanistan and Iran due to sanctions primarily imposed by the United States, with significant support from the European Union, Canada, and Australia.

Dr Ehsan states, “Sanctions on Iran and Afghanistan are another pressing issue as limited formal banking channels with countries such as Iran and Afghanistan make transactions difficult, often forcing exporters to trade via informal channels. International sanctions on Iran also impact projects like the Pakistan-Iran gas pipeline and limit opportunities for Pakistani exports.”

In April last year, Pakistan indicated its intent to request a waiver from U.S. sanctions to allow gas imports from Iran following the approval of the construction of the Pakistani section of the long-planned cross-border pipeline.

However, not only was the waiver not granted, the U.S. has recently imposed additional sanctions on Iran’s “shadow fleet” of oil tankers.

Since most trade between Pakistan and Iran occurs through unofficial channels, no reliable data is available. Nonetheless, the two nations emphasize the significance of their advantageous locations as entry points to the Middle East and Central Asia, using the Shanghai Cooperation Organization’s platform to promote economic cooperation.

Afghanistan has recently invested $35 million in Iran’s Chabahar Port, signaling a shift in its economic and trade strategy. This investment aims to strengthen Afghanistan’s commercial capacity and provide access to international waterways, bypassing traditional trade routes through Pakistan.

This move follows growing economic ties between Iran and Afghanistan, with plans for a commercial complex and special economic zone at Chabahar. Analysts view this as a strategic decision to reduce dependence on Pakistan, which has imposed trade barriers and taxes, forcing Afghan traders to seek alternatives.

India has played a significant role in this development and has also invested in Chabahar Port to provide Afghanistan with an alternative trade route bypassing Pakistan. Chabahar, Iran’s first deep-water port, offers India access to Afghanistan and Central Asia, which is crucial for trade, as Pakistan does not allow India land access for such exchanges.

India’s involvement in Chabahar helps counter Western sanctions on Iran, strengthens India’s geopolitical influence in the region, and ensures a trade route independent of Pakistan.

Demand-supply mismatch

“Demand-supply mismatch is another crucial reason for lower regional trade, as neighboring countries such as India and Bangladesh have similar export profiles to Pakistan. For instance, all three countries are competing with each other for textile exports in the European market,” Dr Ehsan pointed out.

Failure to leverage agreements with China

Pakistan’s trade dynamics with China are shifting, with trade deficits increasing alongside growth in both exports and imports. Pakistan has an estimated export potential of $10 billion in sectors such as rice, medical instruments, bovine meat, maize, and cotton t-shirts. However, the country only exported goods worth $2.8 billion in 2023, according to ITC trade map data.

The China-Pakistan Free Trade Agreement has played a crucial role in boosting trade between the two countries. The second phase of the agreement offers expanded preferential access for Pakistani exports to the Chinese market.

However, Pakistan has failed to fully leverage this potential, as its utilization rates of concessions offered under Phase II are much lower than China’s — 32.3% compared to 79.8%.

Pakistani products, particularly in key sectors such as textiles and clothing, agriculture, and pharmaceuticals, can be sold to China at lower tariffs or without tariffs, making them more competitive. If the free trade agreement is renegotiated to double zero-tariff access, Pakistan could potentially increase its exports by $5.6 billion.

Despite these benefits, challenges remain for Pakistani exporters. One major challenge is that they need to improve the quality of their products and ensure they meet China’s strict product standards and regulations. Only by complying with these standards can Pakistan fully capitalize on the trade concessions.

There is significant potential for Pakistan to boost exports to China, particularly if non-tariff measures on high-demand products are addressed. According to United Nations Trade and Development data, the medical and surgical instrument sector faces 480 interventions that affect Pakistan’s exports. China implements 631 harmful interventions in this sector, the highest in the world, followed by the U.S. with 175 and India with 111.

The China-Pakistan Economic Corridor (CPEC), a framework for regional integration, can also be leveraged. However, Pakistan’s debt sustainability issues and delays in completing many ongoing projects could limit lending from China.

Unrealized trade potential

Pakistan has an export potential of at least $24 billion in regional trade countries, mainly driven by sectors such as textiles (more than $500 million), cereals and agricultural products (more than $240 million), and fruits and vegetables (more than $130 million), according to the export potential map of the International Trade Centre.

Moreover, the top 10 exports accounted for 79% of total exports to regional countries, indicating that exports are highly concentrated.

What can Pakistan do?

Pakistan is on the right track regarding its macroeconomic and exchange rate stability. The current International Monetary Fund (IMF) Extended Fund Facility program will help Pakistan finance its external gap stemming from the current account deficit and repayments of principal amounts.

However, investor concerns about Pakistan’s debt sustainability could lead to periodic fluctuations in the domestic currency, especially if issues arise during IMF reviews.

On a broader level, sustainable export growth remains a key potential for Pakistan in the long run. During his weeklong trip to Washington, D.C. in October, Pakistan Finance Minister Muhammad Aurangzeb argued that sustainable economic growth can only be achieved by boosting exports rather than relying on foreign loans.

Leading in innovation but not in exports

There is no doubt that Pakistan has potential — the country has outperformed in innovation for the third consecutive year, ranking among the fastest-growing economies in the 2024 Global Innovation Index and emerging as one of the world’s largest improving innovation ecosystems.

The index notes that “Pakistan produces more innovation outputs relative to its level of innovation investments,” highlighting the strong spirit and potential of ordinary Pakistanis as key drivers of innovation. This unusual fact raises questions about why this development is not being leveraged in export reforms.

Pakistan can create more technologically advanced products, such as glassware, paints, machinery, and pharmaceuticals.

The chart for the country’s diversification frontier depicts the relationship between a product’s technological complexity and its “relatedness” — a metric that assesses the feasibility of increasing competitiveness in that product based on Pakistan’s current export basket. However, Pakistan must provide a level-playing field for businesses and refrain from implementing targeted regulations to select winners to expand production in these more sophisticated industries.

Trade with landlocked countries

Addressing under-invoicing, smuggling, and misuse of the former Federally Administered Tribal Areas and Provincially Administered Tribal Areas, along with offering incentives to transporters for operating regular freight services between Pakistan and encouraging Pakistani companies to adopt Free on Board terms instead of Cost and Freight or Carriage and Insurance Paid, can improve logistics.

This approach will help revive trade by ensuring that Pakistani exporters maintain ownership of the goods during transit, while importers in the CARs will pay for freight transportation rates.

Several factors can be instrumental in driving export growth, including the 1% advance tax on the realization of foreign exchange proceeds, the expansion of duty drawback schemes, and the resolution of time-barred DLTL cases through one-time settlements.

Additionally, the establishment of an EXIM Bank branch in major industrial hubs, developing a robust business-to-business-to-consumer framework, and revising the tariff structure can contribute to increasing Pakistan’s exports.