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Current account returns to deficit: Future implications

Sharjil M. Haque
FOR the first time in around two years, Bangladesh current account slipped into a deficit in September 2014. A slump in exports, coupled with a hike in imports, was the main reason behind the current account falling back into the undesirable negative territory. A look back in history shows current account in Bangladesh has generally registered a surplus, marred occasionally with temporary deficits. Consistent rise in remittance was the cushion in offsetting our trade deficit over the years.
Now with the deficit back again, a risk of volatility in exchange rate is also on the cards. Since adopting the floating regime in 2003 (or more accurately a "managed" float for Bangladesh), the currency has been subject to two major episodes of devaluation following current account depreciations. The first one in 2005, and the second one -- perhaps far more fresh in our readers' minds - was in 2011. For developing countries like ours, spiralling current account deficits and uncontrollable currency devaluations transmit panic waves and suggest significant macroeconomic weakening. As such, it becomes necessary to understand how the current account determinants are positioned compared to the past and what implications the central bank needs to consider in order to deal with the deficit.
Strong strides away from unproductive imports
Led by capital machinery and petroleum and petroleum products, total imports have grown at 11% in the first quarter of FY 15. This suggests that business confidence after national elections has returned, at least to some degree, and entrepreneurs are looking to revive momentum in industrial activity. However, some are taking this import figure with a grain of salt Since credit growth in private sector is still nowhere near the monetary policy target, there is increased speculation of the possibility of money laundering inducing these encouraging numbers. Money laundering is not a new issue, and has been present in previous years' figures of imports as well. It would be a herculean task to determine what portion of import growth is due to money laundering. But attributing the entire growth in imports to such factors (whether they are true or not) may not be a prudent analysis.
What is undisputable is that imports of consumer and intermediate goods - two items which together compose 50% of total imports - have both registered negative growth during the same period. Comparison with the composition of imports in EY 11 reveals a strikingly different story. Total imports rose by 42%. One of the reasons for this abnormal hike was a rise in global food prices in 2011. But what one cannot overlook is that the economy saw a staggering 55% growth in consumer and intermediate goods - including non-food items.
Essentially, these numbers imply that Bangladesh, aided by prudent policies by the central bank, has made a gradual shift away from unproductive imports -- a transition which must be strictly maintained for growth in capital productivity.
External downturn or internal constraints: Which is easier to overcome?
The last time Bangladesh faced current account deterioration, exports had actually posted impressive growth. The story is quite different this time, and perhaps more unfavourable from a macroeconomic stability point of view. Exports grew only 1% in the first quarter of FY 15. This decline is perhaps the most alarming macroeconomic downturn in recent history, given our reliance on exports for economic growth. Fall in cotton prices in global markets have deteriorated our RMG export performance and taken down nominal exports.
a macroeconomic stability point of view. Exports grew only 1% in the first quarter of EY 15. This decline is perhaps the most alarming macroeconomic downturn in recent history, given our reliance on exports for economic growth. Fall in cotton prices in global markets have deteriorated our RMG export performance and taken down nominal exports.
But is Bangladesh the only one to feel the hit? The answer is a resounding "No." Global gains in supply and fall in demand pushed down prices across the board. Oil, energy, industrial metals, agriculture - everything has taken a battering since around April 2014. Naturally, manufactured-product exporters have felt the pinch. The argument is that
terms of trade have declined for many countries globally; what we need to remember is that the downturn in exports is not due to internal or country-specific constraints. Fundamental internal challenges might have driven out buyers and permanently reduced prospects of future growth.
This sub -par performance in exports will last as long as global demand remains stagnant, but with the world's richest economy already posting better-than-expected growth rates in 2014, a turnaround may not be too far away. According to the International Monetary Fund, global growth rates are expected to pick up from 2014 and continue that trend in the coming years. Even the most dubious economic zone at present, the Euro Area, is expected to move out of recession in 2014. Once this happens, demand will rise first for essential items. Bangladesh will reap the benefit of specialisation in basic ready-made garments.
The real risk: Loss of traditional hedge
Remittance is the one factor which has helped us ensure current account surplus despite running trade deficits. The last episode of severe current account depreciation was brought about partially by a rare fall in remittance growth. With negative growth in remittance last year, one might think the symptoms of current account depreciation are the same as 2011. Butacloser lookshows that thefirst quarter ofFY 15 saw a 21% growth in remittance over the last year. With fears of political turmoil dissipated, coupled with seasonal factors, migrant workers sent more money back home.
What remains a critical concern is the stagnation in growth of manpower export - largely attributable to recruitment restrictions by traditional markets like UAE, Saudi Arabia and Kuwait Despite talks by the government to setup manpower export channels with countries like Malaysia and Qatar, there is still no tangible surge in overseas recruitment.
So for once, this long-reliable macroeconomic driver is no longer present to hedge current account depreciation when trade deficit widens. With history serving testament to the critical role remittance has played for Bangladesh, it is high-time the government allocates sufficient resources and creates stronger diplomatic links with new markets to enhance labor export.
Reservoirs of reserves: Greater control over exchange rate Foreign exchange (FX) reserves can be a useful indicator to predict the central bank's control over the exchange rate. The last current account depreciation witnessed a currency devaluation of 17.8% despite central bank interventions. During this period, EX reserves fell below the minimum level of $ 10 billion required for three months of imports. Naturally, at such levels, EX cannot be used to peg the rate anymore and hence depreciation was inevitable.
In stark contrast, today Bangladesh sits pretty on a record pile of over $21 billion of EX reserves. With FX stock worth approximately seven months of imports, the central bank today has the capacity to avoid currency depreciation - if it wants to.
But the dilemma for Bangladesh Bank is no longer about avoiding depreciation - it has become one of whether to allow depreciation. Because with exports on the downturn due to external factors, allowing theTaka to depreciate may be the only option to improve export growth, at least until global demand normalises again. A small depreciation, well within people's expectations and below panic levels might actually have greater upside potential than downside risk.
Final thoughts
A lot seems to have changed in just around three years. The economy has made strong gains in some areas while lingering doubts remain in others. But armed with greater reserves and stronger policy framework oriented towards productive imports, the central bank seems better poised than before in keeping the current account deficit within controllable limits. What remains is stronger initiative by the government in creating strong diplomatic connections with potential labour-export markets to revive remittance. Once these initiatives work in tandem, Bangladesh can look at current account deficits without fear of macroeconomic instability.
The writer is a Graduate student in International Economics, Johns Hopkins University, USA.
Email: shaque4@jhu.edu