The current account deficit dipped by 5 percent to $4.8 billion in 4MFY19 – such small reduction does not mean the currency adjustment and monetary tightening are not yielding results. The deficit started soaring in the second half of the last fiscal year, with average monthly deficit at $1.7 billion during Jan-Jun18 – it is down to $1.2 billion (30%) per month during Jul-Oct18.
The impact of tightening takes time to translate in numbers and in the months to come, the CAD may fall further - it is 4.8 percent of GDP in Jul-Oct18 and may reduce to 4.0 percent of GDP ($12bn) for FY19 versus 6.1 percent of GDP ($19.0bn) in FY18.
The efforts to curb twin deficit may gather pace with an upcoming IMF programme. The buzz is that it would be a tough programme and government may have to lower subsidies (energy related) and increase taxes to lower fiscal deficit which in turn would help curb CAD. Rumor has it that the IMF may implicitly ask for further currency adjustment and hike in interest rates to curb import demand and push exports up.
The currency depreciation impact on reducing trade deficits is over played in theory; but it surely would help reduce current account deficit. For instance, in the case of Egypt, its currency depreciated by over 100 percent from EGP/USD at 8.88 in Sep16 to 17.86 by Mar17 - in around 18-21 months from the time of sudden depreciation, the CAD reduced from its peak at $5.2 billion during Jul-Sep16 to a mere $493 million in Apr- Jun18.
The intriguing finding is that the trade balance of Egypt has virtually remained unchanged despite doubling the currency levels - It was $9.4 billion during Jul-Sep16 and recorded at $9.3 billion in Apr-Jun18. The imports and exports both proportionately increased in the course of time. The impact of currency adjustment is visible in travel (tourism) and home remittances - the two heads cumulatively increased by $4.4 billion in the said time while the CAD reduced by $4.7 billion.
The story of Pakistan is heading in the same direction. The trade deficit is up by 7 percent in Jul-Oct to further erode the CAD despite 27 percent depreciation since Dec17, but the home remittances are up by 15 percent to marginally lower the deficit.
There is not much room left in reducing imports as majority of Pakistan imports are inelastic in nature - meeting energy, food, industrial and machinery needs. Yes, machinery imports may fall as economic slowdown is having its toll on both government development and private sector expansion plans. The other dent could be on non-essential imports which are not higher in number and are perceived to be grossly under-invoiced. In 4MFY19, imports are up 6 percent ($1.0bn) to $18.4 billion.
In case of exports, there is not much to take home yet - in Jul-Oct18, the export proceeds are up by mere 4 percent ($308mn) to reach $8.0 billion. The ongoing US-China trade war might adversely affect Pakistan exports to China which are mostly rerouted to US and other developed markets after value addition. And seeing from Egypt experience, the impact of currency depreciation may not be much on exports.
The key to boosting exports depends on other economic and non-economic factors - such as enhanced market access to China. Pakistan needs to extract benefit from US-China trade war - China imports corn from the US, and it may be looking for new markets for corn. Pakistan can replace some of its wheat growing areas to corn to generate exportable surplus. A this moment, the country is exporting surplus wheat at hefty subsidy due to price distortion at home.
Similarly, the renegotiation of FTA with China can inch up exports, by getting market access. The other factors of exporters’ refunds and energy and other inputs at competitive rates can further help boost exports.
The world today operates in production value chains, and every region (country) has its own competitive edge to be part of the chain to boost its trade - Bangladesh imports majority of it textile raw material to re-export it after adding value in the form of garments. The case of Vietnam in numerous industries is no different.
The point is that currency adjustment would increase the cost of exporters (by having higher imports) proportionately to hike in exports - see the Egyptian experience. The real exports can only be boasted by finding new product lines to exports and for that FTA negotiations with various trade partners are required and new industries are to be hosted in CPEC SEZs and other economic zones.
Having said that, trade balance is highly insulated to currency movement in modern world, the positivity to be flown in from home remittances. The impact is already reflected in numbers. However, the exchange rate policy must not be solely based on reducing CAD by boosting remittances. There are other ways to boost remittances while the cost of currency depreciation is much more on overall domestic economy.
The government has recently announced a crackdown on hundi-hawala; and this can reroute the inward remittances from grey channels to formal banking and exchange companies routes. The under-invoicing of imports and other money sent abroad through grey channels are netted by inward remittances without money crossing border - for details read' Understanding the remittance growth" published on Nov 15, 2018.
The bottom lineis that the currency depreciation of 27 percent since Dec18 is enough as the REER is now close to equilibrium, and any further adjustment can be counterproductive. However, the IMF may be keen on making currency market a total-free float against managed flow today. The EAC meeting was called by FM in response to the IMF demand of free float currency - the house was unanimous that the existing currency levels are adequate and we should manage currency flows in an otherwise thin market which could easily be manipulated.
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