A trade deficit occurs when an economy is importing more goods than it is exporting. The deficit equals the value of goods imported less the value of goods being exported. For example, Pakistan is importing goods worth USD 15 billion from China while exporting goods worth USD 1.8 billion only, the trade deficit with China would be USD 13.2 billion.
However, a country’s net receipt and payment positions are computed with the help of other accounts known as current and financial accounts which are then totaled to arrive at the balance of payments figure. The current account is used as a measure for all the amounts involved in importing and exporting goods and services, any interest earned from foreign sources and any money transfers between countries. The financial account is made up of the total changes in foreign and domestic property ownership. The net amount of these accounts is then consolidated to arrive at the balance of payments position.
Some of the impacts of prolonged trade deficit on the economy of a country especially the financial sector are highlighted below:
- Since the economy would be more dependent on imported goods, many of the local industries would close down with the passage of time. The economy would be transformed into a trading house rather than manufacturing hub. Ultimately, the need for financing would decline affecting adversely on the profitability of the financial sector.
- With fewer investment opportunities available domestically, the investors would begin to invest in foreign markets where the conditions are more conducive. Currently Pakistan is facing a similar type of situation. The decline in domestic business has led to an outflow of funds to other countries like Bangladesh and African countries.
- The adverse balance of trade accompanied with adverse balance of payments resultantly would have negative impact on the external value of the domestic currency. It would fuel inflation and the public confidence in the domestic currency would be weakened. The prolonged foreign borrowing would enslave the domestic economy on the terms dictated by the lenders. Pakistan had been approaching, time and again, International Monetary Fund (IMF) and other lending agencies for borrowing to meet trade and balance of payments deficits. Consequently, the policies pursued by the economic managers are many times against the interest of the country to comply with the conditionalities attached by the foreign lenders.
Adding fuel to the fire, if Pakistan is black listed by Financial Action Task Force (FATF), then it would have undernoted adverse consequences for the country:
- The foreign buyers would avoid placing their orders with Pakistani exporters because their consignments would be subject to more detailed scrutiny and examination at the port of discharge. Consequently, the exports from Pakistan would be affected further which are already under serious pressure due to lack of competitiveness and value addition.
- Pakistan’s balance of payments is drawing major support from the funds remitted by Pakistani expats. If Pakistan is black listed, these remittances would be subject to more scrutiny at the point of origin. Consequently, they would avoid remitting their funds through regular banking channels and would prefer to use unofficial channels like hundi, hawala etc. resultantly, the country would be deprived with a good amount of foreign exchange having an adverse impact on the country’s balance of payments.
In order to minimize the negative impact, the bankers should educate Pakistani exporters to suggest the foreign buyers to route their business transactions relating to Pakistan through branches of Pakistani banks operating in their country and where Pakistani banks are not operating, list of correspondents should be shared with them for their guidance.
The remittance by Pakistani nationals working abroad is a source of great support to Pakistani government to manage its balance of payments. To preserve this lifeline, the Pakistani expats should be informed about the benefits of routing funds through normal banking channels and close liaison should be maintained with them wherever possible.
[box type=”note” align=”” class=”” width=””]The writer is a Karachi based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan[/box]