Rising current account deficit: How vulnerable are we?
There is a growing concern over our rising current account deficit in recent times. By now it's common knowledge that falling exports and remittances coupled with rising imports have brought about a deficit of USD 2 billion compared to a surplus of over USD 3 billion in fiscal year 2015-16. Sure, no one likes the idea of paying more than what one earns, so it's natural for economic commentators in Bangladesh to voice concerns over potential threats to balance of payment, foreign reserve and exchange rate stability. That said, some points floating around these days need rethinking so we can get a clearer picture of our external macroeconomic condition.
First things first, let's recall that a current account shows the flow of goods and services, primary and secondary income between a country and the rest of the world. Generally, the largest component is trade, and in Bangladesh's context, remittance flows also constitute a large share. The current account, together with the financial account, makes up a country's balance of payments (BOP) which essentially represents all transactions between the country's residents and non-residents.
The financial account is made up of transactions in financial assets: direct investment, portfolio investment in stocks and bonds, other investments including trade credit and loans, etc. Historically, Bangladesh's balance of payments mostly involved current account transactions, but in recent years increase in foreign direct investment, foreign loans, trade credits, etc. led to large surpluses in the financial account. Indeed the surplus in the financial account more than offsets our current account deficit resulting in an overall BOP surplus (increasing our foreign exchange reserves to over USD 30 billion).
So why is everyone worried if we are still receiving more dollars from the rest of the world than we are paying back? Perhaps because we were used to seeing huge BOP surpluses in the last few years, in excess of USD 4 billion every year, and now that has dwindled to around 2 billion.
Let's not forget that a large current account surplus means we are stuck with a lot of savings and not making the best use of our money at a time when the country needs to utilise all its resources for faster development. On the other hand, a current account deficit, if driven by the right reasons, is actually quite healthy for a developing economy. If the deficit is due to massive import of capital machinery, then we are essentially doing what we need to do to catch up with the developed nations: spurring faster, sustainable and inclusive growth through greater public and private investment. In fact, central bank statistics indicate that capital machinery imports have indeed risen. But paradoxically, private investment is barely increasing. As many have already identified, this is a clear indication that money is being siphoned off to foreign shores through creative trade-invoicing. That coupled with slower remittances and exports (the latter due to rapid appreciation of the real effective exchange rate) has created an 'unhealthy' current account deficit.
So how can we reverse this trend? Diversification of our export basket and destinations for manpower export is more of a longer-term vision. The short-term solution will naturally be to tinker around with the exchange rate. Everyone wants a nominal depreciation of the exchange rate going against market forces. This is not an easy task nor does it prevent appreciation of the real effective exchange rate as long as our inflation rate is much higher than countries with which we trade. The sustainable solution is to bring down our inflation rate to 3-4 percent.
Here again Bangladesh faces political resistance: too many influential stakeholders will demand higher money growth because, to them, it means cheap credit under the pretext of faster economic growth. In reality, without proper infrastructure, higher money growth will only generate more inflation, further appreciate the real effective exchange rate, reduce our external competitiveness, deteriorate our trade balance and worsen our current account deficit.
If our financial account surplus remains stable over the next few years, risks of BOP instability from a current account deficit should remain comfortably contained. In this context, it's worth mentioning another argument put forth in our print media recently, which criticised the idea of financing current account deficit with a financial account surplus. One argument goes that we are basically selling off our assets to pay for foreign goods and services! If that is the best way to think about it, why should we encourage foreign direct investment where we allow an external investor to buy our land, set up factories or invest in local companies? Such arguments ignore the multiplier effects of foreign investment—access to foreign technology, more quality jobs, and greater output all of which will enable our own citizens to purchase more foreign goods as well as foreign assets leaving us better off in the end. Similarly, if the financial account surplus is driven by concessional or low-interest loans, then we are using cheap funds to pay for new roads, bridges and overall better infrastructure. No one needs reminding the positive spillovers from better infrastructure.
So unless there is a major domestic shock (political or security-related) there is not much reason to believe that FDI will fall drastically in the near-term amidst the government's continued efforts to increase foreign investment. Indeed, net FDI inflows rose almost 28 percent in July-May of fiscal year 2016-17 and constituted 40 percent of our financial account surplus. If the surplus was primarily driven by speculative foreign investment in stock and bond markets, then we would need to worry about the stability of these inflows. But that's not the case, so by and large our means to pay for the deficit in the current account appears to be reasonably stable.
For now, our current account deficit is not big enough to be too concerned about. There are many economies which run deficits of 2-3 percent of GDP—ours is less than 1 percent. But steps need to be taken to address the slump in exports and remittances, and to stem illicit financial outflows through trade mis-invoicing so that the deficit does not spiral out of control. Some will argue for better administrative and technological capacity to identify such illicit outflows. But perhaps we should think more about incentivising people to keep their money inside the country by generating more confidence in our economy, institutions and political system.
For starters, we need to improve our infrastructure, reduce cost of doing business and clean up our state-owned enterprises. We need to develop domestic asset markets. Above all, the government needs to show that politics does not get in the way of major economic policies. To be sure, that's a lot easier said than done.
Sharjil Haque is a PhD student in Economics at the University of North Carolina, and a former research analyst, International Monetary Fund, Washington DC. Email: sharjilmuktafi.haque@gmail.com
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