A silently ticking bomb

While the marginal current account surplus is being touted and cherished by policymakers, its equally important - but usually sidelined - sister-component of the balance-of-payment has not been making the headlines yet. However, it appears that soon it will.
The last fiscal year saw a fall of 32 percent in capital account surplus, from $175 million in FY10 to $119 million in FY11. Although, the fall is not as alarming as that last year, when it dropped 61 percent year-on-year, the fact that the capital account balance has been consistently deteriorating should raise eyebrows in policymaking quarters.
In theory, a fall in capital account balance has a resultant impact on the foreign exchange rate. However, the average annual exchange rate fell by only two percent in FY11 year-on-year.
This marginal decline in the exchange rate owes a lot to the surplus in the current account, which is doing quite well and balancing out the negative impact of the capital account on the BoP. At the same time, the comparison benchmark, the USD has been relatively weak compared with other currencies because of which the PKR has not depreciated much.
One of the major determinants of the capital account is the Foreign Direct Investment (FDI), which declined by 27 percent, from $2151 million in FY10 to $1574 million in FY11. This downward trend in the net inflow of FDI is due to several reasons.
After the financial crisis of 2008, there was a significant slowdown in the investment by international banks. The booming telecom sector also faced an eventual saturation which resulted in the decline in the FDI. The law and order, policy discontinuity and the uncertain political situation in the country are other important impediment of investment.
FY11 also saw a drop in foreign portfolio investment as the supply of cheap money dried up a bit while at the same time, global liquidity moved away from emerging and frontier markets to developed ones.
Since both FDI and foreign portfolio inflows are unlikely to gather steam any time soon, the fate of BoP relies heavily on current account surpluses. Also, consider that the commodity price boom is gradually tapering off, along with the uncertainty over remittances i.e. whether it will continue on its record-making spree or not.
Add to these fears, the repayments of the IMF loan of $1.2 billion, due to begin this year, and one can expect the currency to come under pressure soon, and the capital account to start making the all the wrong kind of headlines.