Current account deficit and development goals

Asjadul Kibria | Published: September 22, 2018 22:30:23 | Updated: September 23, 2018 21:45:50

The goal of the medium-term development plan is sustainable development with a higher economic growth. To achieve the goal, the Seventh Five-Year Plan (7FYP) has outlined a series of guidelines with projected outcomes. The projection of the balance of payments (BoP) is one of them which stresses on maintaining stability of the country's external balance.  

But the current account deficit jumped from $1.31 billion in FY17 to $9.78 billion in FY18. This deserves a close look.

Current account deficit is not always a bad thing. According to the 'Back to Basics' (a feature series) of the International Monetary Fund or IMF's Finance & Development magazine: "If the deficit reflects an excess of imports over exports, it may be indicative of competitiveness problems, but because the current account deficit also implies an excess of investment over savings, it could equally be pointing to a highly productive, growing economy. If the deficit reflects low savings rather than high investment, it could be caused by reckless fiscal policy or a consumption binge. Or it could reflect perfectly sensible inter-temporal trade, perhaps because of a temporary shock or shifting demographics."

Determining the real impact of current account balance is a tricky issue. It varies from country to country.

Current account balance is one of the important indicators of an economy and interlinked with its savings and investment pattern.

Current account is one of the three pillars of balance of payments (BoP). Two others are: capital account and financial account. Traditional economics text books put the financial account as a part of capital account. But the International Monetary Fund (IMF) uses these three accounts as the three major components of BoP. IMF manual to calculate the BoP is designed accordingly and now being used globally.

Current account records the regular trade transactions of a country with the rest of the world and some unilateral transfers. It includes both trade in merchandise and services as well as income and cash transfers. Trade account is the largest part of current account. That's why, higher trade deficit usually fuels current account deficit.

When import becomes higher than export, trade balance turns negative which is termed as trade deficit. Bangladesh has always trade deficit with the rest of the world. In FY18, the merchandise trade deficit stood at $18.25 billion, almost twice as much the previous year's. Big surge in merchandise import which recorded 25 per cent growth over the previous year against a moderate 6.50 per cent growth of export widened the trade deficit. Service trade gap also increased to $4.5 billion in the past fiscal year from $3.28 billion in FY17.

The difference between lower national savings (both private and public) and higher investment is also reflected in the current account deficit. In FY18, gross national savings of the country was estimated at 28.07 per cent of the Gross Domestic Product (GDP). At the same time, gross investment stood at 31.47 per cent of GDP. Thus, savings and investment gap stood at -3.4 per cent of GDP in the past fiscal. It means that domestic investment is not sufficient to finance the investment requirements and so the country has to resort to loans and grants. 

Current account deficit is not a stock, but a flow and it requires continuous financing. The financial account of the BoP shows the sources of financing the deficit. Financial account records transactions involving financial assets and liabilities and that take place between residents and non-residents of a country.

A country can finance the deficit through foreign loans and investments. In FY18, Bangladesh financed three-fifth of the deficit through medium- and long-term loans. Foreign direct investment (FDI) and short-term loans financed the rest.

Bangladesh is thus gradually accumulating medium and long-term liabilities. It is mainly due to decline in FDI in the past fiscal year by around eight per cent. Medium and long-term loans jumped by around 80 per cent and other short-term loans by 89 per cent in the same period.

As the incremental import bills pushed the deficit and consequently foreign borrowings, it requires a careful review of the merchandise import. The surge in import has already put pressure on the exchange rate. Bangladesh Bank statistics revealed that Taka depreciated by 3.70 per cent in the past fiscal against US dollar.

The rate of depreciation appears tolerable. Some also argue that the central bank intervention contained further depreciation of the local currency. If the local currency is fully market-based, dollar becomes costlier which, in turn, pushes up import bills. This may slow down import growth and eventually reduce current account deficit.

Deficit in the current account balance was, however, predicted in the medium-term planning document. The 7FYP projected that current account deficit would stand at $3.48 billion in FY17 and increase to $4.84 billion in the next fiscal year or FY18. The document projected that country would start experiencing negative balance in current account since FY16 when it was $2.42 billion. In reality, current account balance posted a record surplus of $4.26 billion in FY16. In the next two years, the surplus turned into deficit as projected in the 7FYP. But in FY18, actual deficit was double of the projected value of $4.84 billion. (See: Table). The underline assumption of the projection was that the growing import-intensive investment and general import demand would push the overall import during the period. At the same time, there would be increase in FDI in major export-oriented sectors and in infrastructure projects. Increase in FDI would contribute to a larger surplus in the financial account.

While import has increased in line with the projection of $56.70 billion, export has posted a big shortfall of the projected value of $42.0 billion. As a result, the actual trade gap has overshot the projected value of $14.70 billion by a big margin of $4.0 billion. There was also a big shortfall of FDI. Against the projected value of $5.87 billion, the estimated gross inflow of FDI stood at $2.80 billion in FY18 (See: Table).

However, the financial account surplus reached $9.07 billion which was almost equal to the projected value of $9.18 billion in FY18. Foreign loans financed the large part of the current account deficit and kept the surplus in financial account. 

It thus indicates that the process of achieving the goal of higher economic growth is not strictly following the steps as suggested in the 7FYP plan documents.  The authorities are looking for alternative ways and means. If the alternatives (i.e. foreign loans) for the suggested measures (i.e. foreign investment) become costlier, these may produce unanticipated outcomes, impacting the cardinal goal of achieving sustainable development with higher growth. Current account deficit and financing pattern of development projects may be viewed as a reflection of this deviation from the planned path to development.

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