Concerns about current account deficit

Abdul Bayes | Published: July 30, 2018 22:22:51

Current account (CA) is the most important component of the balance of payments (BOP) of a country. In one sense, its net position reflects health of the economy in terms of competitiveness in the international market. The items in CA include merchandise trade, trade in services, net income, unilateral transfers (remittance) etc. The capital or financial account is the mirror image of the CA in the sense that a deficit in CA results in surplus in financial account and vice versa. The deficit in CA means that the country concerned is indebted to the outside world and a surplus means it's a net creditor. However, there is no reason to believe that a deficit in CA is always bad and a surplus in CA is always good. Even a deficit could be a blessing provided the deficit stems from imports of productive items such as imports of capital machinery and raw materials for industrialisation to boost economic growth.

Of late, the deficit in CA of BOP of Bangladesh has hit newspaper headlines.  It is being reported that Bangladesh's current account deficit is set to cross the $10 billion mark for the first time in history. The deficit is adduced to the country's continued low capacity to export in the wake of increasing appetite for imports. According to the central bank's balance of payments data and as drawn upon available information from other sources, the CA deficit stood at $9.37 billion between the months of July and April of fiscal 2017-18 compared with $2.21 billion in the negative a year earlier. Economists estimated that the deficit-to-GDP ratio will be about 3.50 per cent to 4.0 per cent at the end of last fiscal year. Historically, the ratio hovered between 1.0 per cent and 1.50 per cent in a fiscal year.

A projected deficit of $10 billion would mean the country has borrowed the same amount from foreign sources that will have to be repaid in course of time. In other words, if the trend continues Bangladesh could become an indebted country within a few years.

The deepening of deficit has other ramifications. First, the country has now capacity for settling import payments of maximum five months in contrast to eight months a year ago. This indicates that foreign exchange reserve has gone down.  Second, the appetite for imports appreciated dollar against taka so much so that Bangladesh Bank has already injected about $3.0 billion or so into the market to cool down the foreign exchange market and thus avoid wild swings. In a purely market economy, the central bank need not have to intervene as the law of demand and supply would search for the equilibrium. But for Bangladesh it is 'dirty float' not 'clean float' that seemingly rules.

According to eminent economist Ahsan H Mansur of the Policy Research Institute of Bangladesh (PRI), the turbulence will subside within the shortest possible time if the central bank stopped its intervention in the market. He adds that although the exchange rate of the dollar against the taka will go up suddenly when the central bank stops its intervention, it will bring long-term stability to the market. The interbank exchange rate is reported to have perked at Tk 83.75 per dollar, up from Tk 80.64 a year earlier, according to central bank statistics. This means taka has depreciated against dollar by about 4.0 per cent over one year. Theoretically speaking, the depreciation  should have improved the BOP by increasing  relatively cheaper exports and decreasing dearer imports but the opposite seems to have been happening with less exports earnings and more imports payments.

The on-going volatility in the foreign exchange market could be adduced to various reasons such as capital flight ahead of election, opening of huge letters of credit by importers, and some exporters depositing dollars for rainy days. "Some importers have been afraid of the exchange rate appreciating further in the coming days. So, they are now opening LCs in bulk," said Ahsan Mansur. Capital flight in Bangladesh through over- and under-invoicing is not a new phenomenon. Every year, billions of dollars find ways out of the country through unscrupulous means. Such a flight gets a boost during the election year to perk funds in safer places.

About increased import bills, newspaper reports show that some banks are settling LCs without having the bills submitted which is an illegal way of channelling funds outside the country. The Bangladesh Bank has detected some gross violations in foreign exchange transactions that have raised concerns about money laundering. The violations are reported to have taken place in the following way. First, "letters of credit (LCs) were opened with loans from banks, and the money was transferred abroad to the designated importer's accounts. But then the importers didn't bother to submit the bills of entry -- the document to prove that the goods actually entered the country. In bankers' opinion, it signifies that the goods did not enter the country and money had taken flight. According to BB estimates, about 7.0 per cent of the LCs remains mysteriously unsettled with no bill of entry submitted".

There is no shade of doubt that we should give importance to increasing export and remittance to halt the upward trend of CA deficit. Otherwise, the large deficit will create more pressure on the exchange rate. At the same time, we should also take serious note of the laundering taking place almost regularly through illegal means. Only good governance in the banking sector could stem the rot.

Abdul Bayes is a former Professor of Economics at Jahangirnagar University.



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