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PR Backgrounder# 2, 1 May 2018

Economy

Pakistanâ€™s Current Account Deficit

Meenakshi Vishwanathan

Project Assistant

Only a few months to go till the election and Pakistan is once again struggling to keep its economy from tumbling down.

Pakistan has always had a poor track record of managing its own economy. Although it has somehow kept its economy afloat despite great political turmoil and internal and external conflicts, it still has a long way to go in terms of managing its economy in such a way that it can weather the tumultuous political moods of the country.

If one were to trace the economic history of Pakistan, certain trends to could be identified. Pakistan increasingly relies on loans and grants and then abandons them due to balance of payment crises or because they were required to make policy changes. So far, no major structural changes have been made to the Pakistan economy in order to prevent this crisis.

To understand the issue, it is first important to understand the concept of current account deficit.

Current Account Deficit

In simple terms, a current account deficit occurs when the value of the imports of goods and services of a country is more than the value of goods and services it exports. A current account deficit implies that the net sale made by a country abroad is negative. Usually, only extremely poor countries tend to run current account deficits.

This reflects whether a country is a net borrower or a net lender with respect to the rest of the world.

There are several ways to manage current account deficits. For example, a country can reduce its current account deficit by increasing the value of its exports compared to the value of its imports.

It can also place certain restrictions such as tariffs and quotas on imports in order to curb imports. Simultaneously, the country can encourage its own industries to produce more through various means such as import substitution and industrialization.

Certain monetary policies can also be used to improve the situation temporarily. The country can devalue its currency in relation to other currencies, which in turn reduces the cost of the country’s exports.

More long term plans must also be implemented, such as improve the competitiveness of the domestic companies so that they can compete at a global level.

Regardless of the bleak picture that having a current account deficit presents, a country can still remain solvent while running a current account deficit. The standard method pursued by countries in such an instance is to use external debt to finance investments that have a higher rate of return on investment than the interest rate of the debt.

However, a country can become insolvent if it unable to cover current debt levels with future revenue streams.

Pakistan’s Current Account Deficit: Present Scenario

In the first eight months, July to February, of the fiscal year 2017-18, Pakistan’s current account deficit widened by 50% and stood at $10.83 billion, compared with $7.22 billion in the same period of previous fiscal year.

Earlier in December 2017, the Pakistani government devalued its currency and allowed the rupee to fall by around 5 per cent against the dollar in an attempt to boost its exports. The government also imposed additional duties on imports of over 350 items in order to slow down the imports. More recently, on March 20, 2018 once again allowed the rupee to fall by around 4 per cent against the dollar.

A recent report published by the International Monetary Fund (IMF) on March 14, 2018 summarizes that the widening current account deficit reflects strong domestic demand in the context of an overvalued exchange rate, fiscal slippages and an accommodative monetary stance. As a result of the fiscal slippages of the previous financial year (FY16-17), Pakistan’s debt vulnerabilities have increased.

Although Pakistan, that has maintained a rigid control over its currency, has tried to loosen its hold it still has not prevented the country’s current account deficit from widening. And the dollar reserves have fallen to the lowest in almost three years.

This does not bode well for the Pakistan economy, as devaluing the currency is a last ditch effort to manage current account deficit without relying external debt.

The Foreign Direct Investment (FDI) into Pakistan is also at low levels. At the end of the precious fiscal year (FY2017), FDI had increased just 5 per cent.

What are the options available for Pakistan now?

Devaluing the currency increases the risk of inflation. This in turn would force the retailers to pass in the cost to the consumers. To counter the inflation, the bank may increase the borrowing costs.

Due to the large current account deficit, the rupee will fall sharply against dollar if it is floated freely. So this option might be avoided by the Pakistan government.

Pakistan also has the option of doing nothing. Since elections are around the corner, the current government might try to leave this problem for the next government to solve.

IMF bailout

Pakistan is no stranger to IMF bailouts. If the current scenario continues, then Pakistan will have no choice but to opt for its 13th bailout request in 30 years. For now, the Pakistan government has denied that it might go back to the IMF for help. Even if they were to opt for the bailout, they would wait until the elections are done with in order to reduce the political fallout.

Although these options are available to Pakistan, which route they will take remains to be seen. Furthermore, unless Pakistan shows a willingness to make the necessary structural changes to its economy, this situation will continue to repeat itself in a vicious cycle in the years to come. A solid long-term plan is necessary if Pakistan wishes to have a healthy economy.

REFERENCES

“Current Account Deficit Widens 50% in July-February.” The Express Tribune, 21 Mar. 2018, tribune.com.pk/story/1665247/2-current-account-deficit-widens-50-july-february/.

“Pakistan : First Post-Program Monitoring Discussions-Press Release; Staff Report; and Statement by the Executive Director for Pakistan.” International Monetary Fund, International Monetary Fund. Middle East and Central Asia Dept., 14 Mar. 2018, www.imf.org/en/Publications/CR/Issues/2018/03/14/Pakistan-First-Post-Program-Monitoring-Discussions-Press-Release-Staff-Report-and-Statement-45724.

Mangi, Faseeh, et al. “What's Next for Pakistan After Second Currency Devaluation?” Bloomberg Quint, 22 Mar. 2018, www.bloombergquint.com/markets/2018/03/21/what-next-for-pakistan-after-second-currency-devaluation.