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Thursday March 28, 2024

Record deficit: an upshot of misplaced economic priorities

By Mansoor Ahmad
August 23, 2017

LAHORE: The ever increasing current account deficit should be a source of worry for the economic planners, who, besides learning from the experiences of successful economies, should ban all the unnecessary imports and continue to liberalise the sourcing of new technology from overseas.

There are quite a few definitions of the current account. One of which is the difference between the suitably defined export and import earnings. Higher imports and lower exports give an insight into the level of competitiveness of that economy. Addressing the issue of competitiveness right now would only resolve the current account deficit issue in the long-term and not immediately. Achieving global competitiveness should be the aim of national economic planners.  They would have to introduce numerous reforms keeping in mind that competitiveness is not only the about the prices of goods and services as it also involves their quality, production costs, and the processes by which they are transported and delivered. 

This means that besides encouraging the entrepreneurs to bring in new state of the art technology, the planners would also be required to improve the rail, road and sea infrastructure.  They would have to encourage another set of entrepreneurs. They would have to persuade entrepreneurs to obtain international quality certifications on their processes and procedures. The competitiveness depicts the weakness or strength of an economy. It is in fact a symptom than a cause of what is happening in the economy. Uncompetitive economies are not the only reason of current-account imbalances.  

In fact country’s saving or borrowing from rest of the world gives a better picture about the state of current account.  Current account deficits results from excessive external borrowing. Logically it should be a matter of concern for the economic planners, particularly if the deficit persists so long that it reaches beyond the capacity of the borrowing government to repay. This happens in economies where the loans are taken to finance the fiscal deficit as Pakistan has been doing for many years. 

The current account deficit also becomes dangerous for the economy if such development projects are finances from foreign loans that do not have the capacity to generate enough revenues to service their loans. This has been happening for a very long in Pakistan. 

In fact some of World Bank’s (WB) project loans have turned into a total waste as the bank stopped disbursements after some time because of the failure of the project managers to keep deadlines or the government’s inability to fulfill its part of commitment given to the WB before the start of the project. As a result, these wasted foreign loans were repaid by the nation.

There are many countries that have run huge current account deficit for decades without coming under any repayment pressures. It was because they borrowed heavily to finance productive investment, ensuring that the rate of return on the investment exceeds borrowing costs.

Thus, the more they borrowed the stronger their economies became. In such circumstances, the borrowing country faces no problem in servicing its debt. Australia is one such country that has run high average current account deficit of 7.8 percent of its GDP for decades without any adverse impact on its economy.

If the private sector is the main beneficiary of direct foreign loans the chances are that they get loan after full scrutiny and from different sources. In such cases the chances of defaults are very low if the lenders had done due diligence in sanctioning loans. But the risks are likely to be high if the private sector borrows from domestic intermediaries that borrow externally, because a lack of vigilance on the part of those intermediaries could result in non-performing loans.

Our planners should realise that excessive public spending financed by external borrowing is most risky for the country. It is a well known fact that highly indebted governments can default more easily than private entities. The firms have the option to close down and sell assets to pay off their liabilities. This luxury is not available with the state, which cannot be closed down.

Most lenders panic and stop further lending to a country with large external debt after seeing its inability to repay its debt. This makes it impossible for that country to finance its ongoing deficit.  It is another matter that the foreign lenders that wanted to avoid the crisis create a larger one by suddenly cutting the finances.