Improvement in current account deficit

Rising current account deficit during the last few years has been a major problem area of Pakistan's economy. It rose from almost five billion dollars or 3.9 percent of GDP in 2005-06 to 7.1 billion dollars or 4.9 percent of GDP during 2006-07.
The multilateral financial institutions as well as independent policy analysts viewed such a high level of deficit as unsustainable and called for appropriate policy actions to reverse the deteriorating trend. Thankfully, the data for the first two months (July-August) of the current fiscal year, have shown some improvement in the external sector of the economy. According to the details released by the State Bank, exports (on f.o.b. basis) grew at an average rate of 6.7 percent during July-August, 2007, amounting to 2910 million dollars.
Imports, on the other hand, declined slightly by 0.6 percent to 4624 million dollars. The trade balance, therefore, improved from a deficit of 1924 million dollars to 1714 million dollars. Invisible balance was also in surplus at 269 million dollars as opposed to a deficit of 82 million dollars in the same period last year.
Private transfers registered a major increase of 41 percent or 588 million dollars to reach 2020 million dollars during the period under consideration. Workers' remittances - a major component of private transfers - grew by over 21 percent to 984 million dollars.
As a result of these favourable developments, current account deficit fell from 1996 million dollars to 1434 million dollars during the first two months of the current fiscal year. As a percentage of GDP, it was 0.9 percent of the projected GDP as against 1.4 percent in the corresponding period of last year.
Although it is still premature to say something definitely about the continuation of this trend, we believe that this is a welcome development. Last year, ie during 2006-07, current account deficit was targeted at 4.3 percent of GDP, but actually turned out to be higher at 4.9 percent of GDP. The data for the first two months indicate that the deficit could be lower or close to the target of 8.11 billion dollars during 2007-08. Nobody would like to live with or support even this level of deficit because we would be still living beyond our means, but there is no harm in welcoming a trend which, if continued, could help in overcoming a major structural problem of the economy.
The fact that all the major components of the current account balance, including trade balance, invisibles and private transfers, contributed to the improvement indicates that the positive trend was not due to some chance factor and, therefore, could be sustainable. As we see it, there were two factors which might have been responsible for this healthy development. Firstly, tight monetary policy of the State Bank has reduced demand, including import demand, in the economy which has contributed to a lower import bill and improved the trade balance.
Another positive effect of this policy approach is the decline in the CPI inflation to 6.4 percent during July-August, 2007 as against 8.3 percent in the corresponding period last year. Secondly, although Pakistan has not officially depreciated its currency, since the US dollar is hitting new lows against major currencies of the world and the Pak rupee parity with dollar has not changed, rupee stands automatically depreciated against most of the other currencies. This may have given a competitive edge to our exports.
However, the monetary authorities of the country cannot afford to be complacent about the emerging trend because there are certain negative developments which could adversely affect the current account balance during the course of the year. The prices of POL products are touching record levels in the international market and since the demand of these commodities is almost inelastic, the import bill of the country could surge in the remaining months of the year. The prevailing political uncertainty in the country could also have a pervasive effect on the external sector of the country.
Exports, foreign investment, home remittances etc cannot remain immune from the ill effects of a chaotic situation for long. The country was expecting to earn some foreign exchange from wheat exports but the prospect is entirely different now.
All said and done, the situation needs to be closely monitored in order to ensure a gradually narrowing of current account deficit and maintain the present trend. The country, of course, cannot afford to incur huge current account deficits year after year because of its very serious implications for the economy.