Grimness of external account

The balance of payments (BoP) for the period Jul-Apr 2018 was released last week. It depicts an alarming state of affairs of country's external account. The current account deficit was recorded at $14 billion, which is 5.3% of GDP. This is the highest deficit in nearly a decade. Obviously, it has been contributed by a massive surge in imports, which rose by 17% from $38.9 billion to $45.6 billion. The exports are also rising but are no match to the rise in imports. Exports increased by 14% from $18.1 billion to $20.6 billion. Consequently, the trade deficit increased by 20% from $20.8 billion to $25.0 billion. Helped primarily by workers' remittances, which rose by a small margin of 4% from $15.6 billion to $16.3 billion, the overall deficit was contained to $14.0 billion.
The worrying development is that the month of April saw a deficit of nearly $2 billion (which is annualized to nearly 8% of GDP). If the next two months would lead to similar increases, the deficit would be $18 billion or nearly 6% of GDP. The unsustainability of such a high level of deficit doesn't require much elaboration.
Before we reflect on how this deficit poses major challenges of economic management, let's note that for a developing economy like ours, current account deficit is an indication of rising economic activity. The deficit is essentially foreign savings augmenting domestic savings and making larger amount of resources available for investment, which would be helpful in accelerating economic growth. This year the country has already achieved a growth rate of 5.8% that is highest in nearly 10 years. The current account deficit has enabled this growth performance.
The problem starts when one looks at financing the current account deficit, below the line, after the movements of goods and service have been accounted for. The capital and financial accounts provide the necessary information in this regard.
The capital account movements show a net balance of $304 million, down from $341 million last year. On the financial account, the significant items included foreign direct investment (FDI), public investment (Euro Bonds and Sukuk) and other borrowings. FDI was recorded at $2230 million against $2098 million last year. Public investment was recorded at $2378 million against a net outflow of $637 million last year. The most significant item is the net borrowing of $4522 million compared to $4347 million last year. These four items add up to $9.431 billion. Therefore, against a deficit of $14 billion, financing of $9.431 billion was available leaving a gap of roughly $4588 (after taking into minor items and errors and omissions).
Where is the above gap financed from? The answer is from drawing down of the reserves. At end June 2017, the SBP (official) reserves were recorded 16.144 billion. At end April 2018, the reserves are down to $11,389 million. However, this loss of reserves does not fully capture the deterioration in country's external account in the last two fiscal years. For this purpose, we have to examine the situation from the peak reserves we had achieved, the level of debt we had at the moment and where we stand now. We do this analysis now.
The peak reserves were achieved at around End September 2016 when they reached a record level of $20 billion (gross reserves $24.5 billion). The public external debt at the time was $58.7 billion. In June 2013, the level of debt was $48.1 billion. Thus, until then, over the last three years and a quarter, the Government had added $10.6 billion to debt. However, during the same period, the reserves had increased from $6 billion (gross $11.0 billion) to $20 billion (gross $24.5 billion), a net increase of $14 billion, significantly more than increased debt of $10.6 billion. This should not be surprising as under the IMF program nearly all borrowings were subject to an adjuster in the reserves target: the target would increase by the amount of borrowing.
After the Fund program ended in September 2016 and the economic managers abandoned the discipline of the program, things started unravelling. So, let's contrast the situation that developed since October 2016. The latest numbers available are for March 2018. The debt outstanding was recorded at $69.3 billion. This showed an addition of $10.6 billion in the debt outstanding as on 30 September 2016, namely $58.7 billion. The latest data on debt as of date is not available but we hear that at least $1.2 billion were borrowed from Chinese lenders. So we take the net addition to $11.8 billion. Now, let's see what is happening to the reserves. The latest number available is for 11 May 2018, which is $10.8 billion. So, here is the equation: We lost $9.2 billion in reserves ($20.0-$10.8) and have accumulated additional debt burden of $11.8 billion. This is in sharp contrast to the performance under the Fund program. Taken since June 2013, the Government has added $22.1 billion in external debt during the last five years while net increase in reserves amounted to a meager $4.8 billion.
In its 1st Post-Programme Monitoring Report, IMF had indicated that the level of net international reserves (NIR) was a negative $763 million. NIR is calculated by subtracting the debt maturities falling due in next twelve months, swap/forward purchases of SBP and deposits of foreign government kept with the central bank. As we noted above, things have deteriorated sharply since the Fund report and it would not be surprising if the level of NIR has fallen significantly. When the Fund program was negotiated back in June 2013, the NIR was close to a negative $2.5 billion. It seems, the country has come full circle, after five years, to the same level.
Evidently, the excessive aggregate demand, as manifested in rising imports, would soon lead to exhaustion of reserves. To steer the economy out of this crisis, major adjustment in fiscal, monetary and exchange rate policies would be required. This would be painful for our people as growth would decline and inflation would rise. But the resulting path, hopefully, would be sustainable and not lead to an unstable economy.
(The writer is former finance secretary)
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