Published :
Updated :
For all latest news, follow The Financial Express Google News channel.
In the last fiscal year (FY2017-18), the country's current account deficit reached US$ 1.48 billion and the trade balance hit a record deficit of US$ 9.47 billion. Over the years, the country's increasing gaps in both merchandise and service trades is pushing the current account deficit to higher levels. The largest component, and the one that accounts for most of the deficit, is merchandise trade. The component is also the most important variable accounting for much of the fluctuations in the current account over time.
In general, one may, through using the balance of payments accounting identities, argue that trade and current account deficits are financed by surpluses on the capital account. Since savings are often low in a country like Bangladesh, capital inflows augment private savings and accelerate capital accumulation and economic growth. As such, trade and current account deficits are temporary phenomena that will be corrected through future surpluses generated by capital inflows, higher investment and faster economic growth.
In a country like Bangladesh, it is important to consider several issues such as what a current account deficit really means and the many ways that a current account balance is measured. The current account is expressed as the difference between the value of exports of goods and services and the value of imports of goods and services (it also includes primary income and current transfers such as remittances). A deficit means that Bangladesh is importing more goods and services than it is exporting.
The current account may also be expressed as the difference between national (both public and private) savings and investment. A current account deficit reflects a low level of national savings relative to investment or a high rate of investment-or both. For a capital-poor developing country like Bangladesh, which has more investment opportunities than it can afford to undertake because of low levels of domestic savings, a current account deficit may be expected. Further, Bangladesh may run large current account deficits as a share of gross domestic product (GDP) as these could typically be financed by official grants and loans. Such a deficit may potentially spur faster growth and development if the financial system is efficient and the foreign capital is used efficiently.
A variation of this view often extends the intertemporal consumption approach, which rests on the permanent income hypothesis, to an open economy context and maintains that trade balance and current account fluctuations including associated capital flows are buffers that smooth out consumption in response to shocks to output, investment and government expenditures. As long as saving and investment decisions reflect utility maximising decisions by economic agents, the resulting current account and trade balance dynamics are optimal and intertemporally solvent, even if they are in deficit.
Thus, if the national cash flow (output minus investment minus government expenditures) is expected to increase over time, it is optimal to borrow against future resources (or accumulate indebtedness through capital inflows) by running a current account deficit. Conversely, if the anticipated national cash flow is likely to decrease over time, a country should run a current account surplus, or increase its savings today to maintain future consumption. Besides utility maximising behaviour, these arguments assume that there exist complete, well?established and efficiently functioning global financial markets for contingent securities that allow optimal risk diversification.
The above arguments view trade and current account imbalances as temporary phenomena reflecting rational behaviour of economic agents. However, these arguments overlook the fact that trade and current account deficits in countries like Bangladesh may result from more fundamental development constraints that cause the deficits to persist without corrective measures. The two?gap growth models, for instance, argue that developing countries generally specialise in the production and exports of primary commodities that have a low income elasticity of demand relative to manufactured goods in the global market. Further, these countries meet their requirements for manufactured and capital goods through imports from developed countries. The differences in income elasticities mean that trade deficits may not be automatically corrected over time.
Studies on sustainability of current account deficits in developing countries suggest that several factors contribute to higher sustainability of such deficits, such as growing earnings from services exports, higher imports of capital goods that augment the productive capacity of the domestic economy, and liberalisation of capital flows in a globalised economy. The policy prescriptions of these studies include keeping fiscal deficits under control and further liberalisation of capital flows to sustain current account deficits. However, one major limitation of these arguments arises when crises or structural policy shifts occur in a country which may create destabilising effects due to excessive reliance on capital inflows and challenges that may emerge if capital inflows, remittances or services exports fall in future.
In Bangladesh, one question that surrounds popular economic debate is: does current-account deficit provide a negative economic signal for the economy? Obviously, when Bangladesh runs a deficit on the current balance, it means more is imported than exported. As long as foreigners are willing to finance the difference, this deficit poses no problem. However, in terms of the exchange rate, the current-account deficit may create overall depreciation pressures.
A deficit on the current account, however, does not always imply that Bangladesh is consuming in excess of what it can afford. A deficit may also be caused by economic growth. When the country grows faster than its major trading partners, it tends to import more to sustain economic growth. Since the trading partners are growing at slower rates, they also demand fewer exports because of slow income growth. This results in a deficit on the trade balance. Higher economic growth also provides more attractive returns on invested capital and therefore attracts more foreign investment. This inflow provides a natural financing means for higher economic growth.
A large current-account imbalance may have some social implications. If the country imports more, it might imply that less domestic products are consumed and exported. Domestic jobs are lost to foreign countries. Overall, a current-account deficit is not a bad economic signal as long as foreigners finance this by investment inflows. This is similar to corporate finance where the need for outside financing may be satisfied via debt and equity. As long as investors believe that the company is well-managed and provides attractive yields, they will hold the equity and debt of the company.
As having a current-account deficit is not necessarily bad in an economic sense, the question of sustainability of the current-account deficit is probably a more relevant issue for Bangladesh. A current-account deficit is not a bad thing as long as it is sustainable through a surplus on the financial account. However, when both accounts are in a deficit, foreign reserves will be necessary to fund this shortage.
Further, intertemporal theories of current account stress the consumption-smoothing role that current account deficits and surpluses can play. For instance, if Bangladesh is struck by a shock-a cyclone or other natural disaster-that temporarily depresses its ability to fully access its productive capacity, rather than taking the full brunt of the shock immediately, it can spread out the shock over time by running a current account deficit.
In the above context, the critical issue is: does it matter for Bangladesh if it runs deficit in the current account in a persistent manner? When Bangladesh runs a current account deficit, it is building up liabilities to the rest of the world that are financed by flows in the financial account. Eventually, these will have to be paid back. It is natural that if the country does not use its borrowed foreign funds on spending that yields little long-term productive gains, then its ability to repay-its basic solvency-might come into question.
This is because solvency requires that the country must be willing and able to generate sufficient current account surpluses to repay what it has borrowed to finance the current account deficits. Therefore, whether the country should run a current account deficit (that is, borrow more at present) depends on the extent of its foreign liabilities (its overall external debt) and on whether such borrowing finances investments having higher marginal products than the interest rate (e.g. rate of return) the country has to pay on its foreign liabilities.
Many researchers argue that, even if a country is intertemporally solvent so that it has the potential capacity to cover current liabilities by future revenues, its current account deficit may become unsustainable if it is unable to secure the necessary financing that may result in sharp reversal of its current account deficit if private financing withdraws. Such reversal may become disruptive as private consumption, investment, and government expenditure will have to be curtailed abruptly when foreign financing is no longer available. And, indeed, the country will be forced to run large surpluses to repay the amount that has been borrowed in the past. This suggests that large and persistent deficits call for caution to avoid an abrupt and painful reversal of financing.
Empirical research shows that inadequate foreign exchange reserves, overvalued real exchange rate, excessively high domestic credit growth, unfavourable terms of trade shocks, low growth in trading partner countries, and high global interest rates influence the occurrence of reversals. Recent research also focuses on the importance of balance sheet vulnerabilities in the run-up to a crisis, such as large liabilities in foreign currencies (e.g. dollars) by the borrowers or maturity mismatches that occur when borrowers have more short-term liabilities than short-term assets and more medium- and long-term assets relative to their liabilities.
The research also underscores the importance of the composition of capital inflows-for example, the relative stability of foreign direct investment (FDI) compared with more volatile short-term investment flows, such as in equities and bonds. Moreover, weak financial sector often increases a country's vulnerability to a reversal of investment flows by making risky domestic loans. On the other hand, a flexible policy framework-such as flexible exchange rate regime, higher openness, export diversification, and coherent fiscal and monetary policies-combined with prudent financial sector development can help a current-account-deficit country to become less vulnerable to reversal through creating better shock absorption capacities.
A key policy-related question in Bangladesh is to judge whether a current account deficit is bad or not. The answer to the above depends on factors that give rise to the deficit at a given point in time. If the deficit reflects an excess of imports over exports, it may, for example, indicate problems of competitiveness; but as current account deficit implies an excess of investment over savings, it may equally point to the evolution of a rapidly growing economy. On the other hand, if the deficit reflects low savings instead of high investment, it may reflect the operation of an inappropriate fiscal policy or unsustainable consumption behaviour in the economy. Further, these may be the outcome of temporary shocks or changing demographics.
Therefore, without knowing the underlying causes of deficit, it is futile to describe a deficit good or bad. Current account deficits reflect the overall economic trends of the economy, and the desirability of the deficit depends on the nature of these trends at the particular point in time. In Bangladesh, sustainable solutions to such deficits rest in expanding the supply side capacity of the economy. This will ensure that domestic demand will not exceed supply, which will help to raise exports and decrease imports, forcing the economy back into balance. This can only be done through expansion in infrastructure capacity, securing necessary skills at national and local government structures for inclusive development as well as establishing appropriate sector strategies to improve the economy's efficiency, growth potential and competitiveness in a sustainable manner.
Mustafa K. Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM)