Sharjil Haque
If it was for a large, resource-rich country like the United States or Germany, a current account deficit of around USD 10 billion would be nothing. But for a small developing economy like Bangladesh, a current account deficit of USD 10 billion or four percent of GDP is definitely big enough to sound the alarm.
The current account in Bangladesh, which primarily includes our trade balance and remittance inflows, enjoyed years of surplus before slipping into a deficit last year. And things only went downhill from there with imports rapidly outpacing exports and remittance inflows, eventually bringing us to the situation that we are in today.
In retrospect, we should have seen this coming. Remittances had been running out of steam and could no longer bridge the gap between imports and exports. But what explains the lacklustre growth in exports?
The argument that subdued global demand slowed down exports no longer holds water. World economic activity is enjoying its broadest upsurge since 2010 with big advanced economies like the US experiencing record-low unemployment rates.
For starters, very little progress had been made in boosting exports through lower trade protection, product diversification or reaching bilateral trade agreements. Also, steady appreciation of the real effective exchange rate, from 2012 to 2017, slowly chipped away at our export competitiveness.
Meanwhile, the economy's appetite for imports skyrocketed. Not that it should be too surprising. After all, election years typically mean governments scrambling to spend every last penny in their coffers on some grandiose project to please the public. Whether those projects will be efficiently completed at reasonable costs is a different matter.
There were other factors at play here as well. International commodity prices began to pick up again. And there is growing consensus among economists that capital is being siphoned out of the country by over-invoicing imports. Why else would private credit shoot up to 18 percent after hovering around 13-14 percent for much of the last five years? After all, growth in nominal GDP has not picked up — so where is the excess credit-fuelled import going?
The ramifications of running a deficit this big are deep and persistent. The nominal exchange rate started weakening, prompting the central bank to sell part of its foreign exchange reserves to stabilise the currency. Most likely the central bank did not want imports to become more expensive, which would drive up inflation and hurt public confidence.
But there was one problem. By selling dollars in the interbank market, the central bank soaked up domestic currency (Taka) from the system. At a time when banks had been lending recklessly and dishing out heaps of private sector credit, removing money from the financial system only aggravated a growing liquidity crisis.
Any astute observer of monetary policy can detect that the central bank got stuck between a rock and a hard place. It tried to prevent depreciation by selling dollars and ended up fuelling the liquidity crunch. At the same time, it lowered policy rates and Cash Reserve Ratio to ease liquidity problems. That of course comes along with the risk of higher inflation. And all the while it has to worry about the growing deficit in the current account.
Even if the present deficit can be covered by future income generated by productive imports (assuming they really are productive!), running too large a deficit for too long can eventually become unsustainable. For now, the deficit is financed by a hefty surplus in the country's financial account which brings in foreign loans and foreign direct investment. But if this overseas financing decreases or is withdrawn altogether, the economy will experience a painful disruption in private consumption, investment and government spending. Make no mistake: history is replete with such examples. Thailand and Mexico in the 1990s should be good pointers.
From all indications, we might well see a sizeable deficit this fiscal year as well. Sadly though, authorities only have tough choices left in front of them. It could taper the economy's voracious appetite for imports by raising taxes or lowering public spending. Will the government make such a move?
Highly unlikely, especially right before elections. It could lower trade protection and create a more export-friendly environment. For several years now, leading economists have called for lower tariffs, but time and time again authorities have turned their back on such demands. Resistance from business leaders to opening up our markets to foreign competition has proved to be just too high. That this will seriously diminish Bangladesh's coveted goal of export-diversification appears to have no real impact on the matter.
Meanwhile, we are all hoping to see the government coming down hard on money launderers and banks with lax monitoring and risk management systems, which might at least reduce illicit outflow of funds and curb imports. But progress on this front remains slow and those who want to take money out continue to do so.
The upshot of all this is that the burden of managing external imbalances will fall squarely on the central bank. And the choice ahead is going to be tough: either drying up reserves to keep the currency fixed while adding to domestic liquidity problems or slowly allowing it to depreciate to a new equilibrium. Even if the central bank is wary of further depreciation, there should be no doubt that it is the better choice.
To be sure, some segments of the business community will remind us that imports will become expensive which could drive up inflation. Indeed, trade balance will worsen in the short term. But a cheaper currency will, in time, raise exports and take our trade balance to a stronger and more sustainable level than before—the J-curve effect. Not to mention that remittance inflows will also rise, helping create a healthy stock of foreign reserves. While an antidote of tighter monetary policy (lower broad money and private sector credit growth) can keep a lid on inflation should it start picking up.
We all recognise that these are tough decisions to take, that too just before elections. Leaders of the business sector will use all their influence—and influence they have in plenty—to force authorities to keep the exchange rate stable and monetary conditions easy. Let's just hope authorities can make the right call before things get really out of hand.
Sharjil Haque is doctoral student of economics at the University of North Carolina at Chapel Hill, USA, and former Research Analyst, International Monetary Fund, Washington DC.
- Courtesy: The Daily Star/ Sept 05, 2018
