The latest news on the external sector of the economy are encouraging. According to the data released by the State Bank of Pakistan on 19th January, the current account deficit of the country was down by 78 percent to stand at $1.76 billion during July-December, 2009 as compared with $7.85 billion in the corresponding period last year, due mainly to a considerable increase in home remittances and fall in imports.
In other words, the C/A deficit was just 22.4 percent of what it was during the same period in 2008-09. Remittances from overseas workers rose by 24.4 percent to reach $4.53 billion during July-December, 2009 while imports fell to $15 billion from $18.3 billion in the same period last year. Merchandise account deficit shrank from $8.21 billion to $5.71 billion in the first half of FY10.
The improvement in services and income deficits was also quite significant. The decline in current account deficit by such a hefty margin could only be interpreted as a welcome development. Current account deficit of the country was targeted at last year's level of 5.3 percent of GDP during FY10, but the actual outcome during the first half of the year shows that the improvement could be more substantial than projected at the beginning of 2009-10.
In fact, the SBP projections now indicate the C/A deficit to hover between 3.7-4.7 percent of GDP. It is quite evident that a lower current account deficit would help in overcoming a major structural problem of the economy, building a comfortable level of foreign exchange reserves and stabilising the exchange rate of the rupee.
By maintaining the free flow of imports, the improvement would also result in sustaining industrial activity and softening price pressures on the economy. As we see it, there are at least three factors which could be largely responsible for this healthy development.
Firstly, the tight monetary policy of the State Bank has reduced overall demand in the economy, including import demand, which has significantly contributed to a lower import bill and improved trade balance of the country. Secondly, depreciation of the exchange rate of rupee has also diminished demand and given some competitive edge to our exports.
And thirdly, the recent efforts of the banking system, together with strict monitoring of the exchange companies and the reduction in difference between the official and unofficial rates of rupee seem to have contributed to higher flows of remittances through banking channels. Although, the data for the first half of the year is a cause for optimism, the sustainability of this trend does not appear to be certain.
This is particularly so because the country's current account deficit, in December 2009, was 38 percent higher than a month earlier. Also, the deficit posted an increase of 130 percent during the second quarter of the current fiscal year, as compared to the first quarter, due mainly to rising trade and income deficits.
Besides, doubts are now openly expressed about the rising level of home remittances due to massive job losses in foreign countries and inability of Pakistanis, in general, to find employment abroad. In its quarterly report released on 12th January 2010, the SBP had remarked that the reasons for improvement in remittances were unclear, raising questions on the sustainability of the trend.
Some analysts have also raised concerns that the growth in remittances may be attributable to one-off transfers from those expatriates who have lost jobs in the Middle East, USA and Europe in the wake of global economic crisis. All of this strongly suggests that there is still an element of uncertainty about the improvement in the trend of the C/A deficit. The authorities are, therefore, required to be very vigilant about the emerging situation in the external sector with a view to taking appropriate policy actions in a timely fashion.