Strategising policies for easing trade deficit

After posting the highest ever trade deficit in the past fiscal year (FY18), there is an indication that the deficit is likely to decline moderately in the current fiscal. Besides the trade gap, current account deficit also widened in FY18 and put the overall balance of payments (BoP) under some strain. As a result, for the first time since FY11, BoP turned into red creating a concern over the management of the external sector.
Merchandise trade deficit, however, declined to $7.66 billion during the first half of the current fiscal year (FY19) from $8.62 billion in the same period of FY18. Robust growth in export with sluggish growth in import contributed to reducing trade deficit. Generally, trade deficit or export-import gap focuses on trade in goods. But trade in services also requires attention. Deficit in service trade declined to $1.60 billion in July-December period of the current fiscal which was $2.34 billion in the same period of the past fiscal.
Decline in trade gap coupled with modest rise in remittance also helped to reduce the current account deficit sharply to $3.08 billion during the period under review from $5.06 billion in the first six months of FY18. Current account is one of the three major components of BoP. It shows whether an economy is able to meet its regular foreign exchange requirement by its regular earnings, mostly through export and remittance, or not.
Based on these trends, Bangladesh Bank, in its latest monetary policy statement, projected that both trade gap and current account deficit would decline in the current fiscal year. In its outlook on BoP, the central bank has mentioned that merchandise trade gap may reach at $17.27 billion in the current fiscal which was $18.26 billion in the past fiscal. It also projected that gap in services trade would come down to $3.53 billion at the end of FY19 which was $4.57 billion in FY18.
TRADE DEFICIT PARADOX: There is, however, no hard and fast rule to determine the extent to which trade as well as current account deficits are bad or alarming. It requires detailed review of the movements of the BoPs' components and how the movements impact on the macro economic situation. In fact, any deficit in BoP is not always bad and may sometimes reflect some strength of the economy.
As a matter of fact, trade deficit or trade surplus is not a result of any well calculated measure. Both are outcomes of what an economy purchases from and sell to the rest of the world. By importing more from other countries than selling to them, an economy will face trade deficit. These happen due to inadequate domestic production and supply of different goods. Factors like domestic demand, endowment of natural resources, ability to produce different goods and services, and even local cost of production and transportation are critical in this regard.
In Bangladesh, trade deficit is regular phenomena as export is always lower than import. In the past fiscal year, import registered 25 per cent growth. Bangladesh Bank pointed out that higher demand for investment goods along with flood-related food imports in 2017 drove the big surge in import. But jump in import of capital goods by 33 per cent and intermediate goods by 20 per cent also appears as suspicious to some extent as trade misinvoicing becomes a major tool for capital flight from Bangladesh and many other countries of the world. The latest report of the Global Financial Integrity (GFI) showed that illicit financial outflow from Bangladesh was at least $5.90 billion through the misinvocing of international trade with advanced economies in 2015. Over-invoicing in import or under-invoicing in export opens the door of capital flight. By over-invoicing importers can artificially inflate the import payment and transfer money from home to abroad. By under-invoicing, exporters can show lower earnings and repatriate less than actual amount parking the rest abroad.
It is, however, difficult to detect trade misinvoicing and rise in import is not necessarily always linked with this. What is needed is to strengthen the vigilance of export-import related financial transactions.
Interestingly, import in the first six months of FY19 registered a moderate 5.73 per cent growth over the same period of the past fiscal year. After registering over 25 per cent growth in a year, the slowdown in import indicates that some correction is taking place in this regard. Decline in global commodity price in the last quarter of 2018 also eases some import pressure. The World Bank commodity price indices for low and middle income economies showed that energy price index dropped to 72.7 in December last year from 96.9 in October while non-energy price index declined to 80.8 from 82.3 at the same time. Again, reduction of internal investment demand due to national election in December also played a role to reduce import growth.
Import may increase in the second half of the current fiscal year due to push in different development projects including mega projects. Private sector is also likely to increase investment and production in the upcoming days. Against the backdrop, Bangladesh Bank has projected that import would register 7.5 per cent growth in the current fiscal year while export would increase by 14 per cent. Earnings from merchandise export in the first half of the current fiscal registered 14.42 per cent growth.
PRESSURE ON CURRENT ACCOUNT: Bangladesh Bank further projected that current account deficit would come down to $6.39 billion at the end of FY19. Nevertheless, the deficit has to be financed. The financing pattern is reflected in the financial account which recorded $2.60 billion surplus in July-December period of the current fiscal. Medium and long term loans are the main source of the financing followed by foreign direct investment (FDI). Inflow of FDI increased by 10 per cent in the above mentioned period while medium and long-term loans jumped by 13 per cent.
What is challenging for the country is to attract more foreign investment. Otherwise, incremental foreign loans will increase both the future liability and pressure on foreign exchange. To finance different development projects, foreign credit is, no doubt, an important source. For Bangladesh, foreign credit is going costlier as the country is set to graduate from the Least Developed Country (LDC) category. Moreover, private commercial borrowing is also on the rise. It jumped by 32.54 per cent in the past fiscal over the previous fiscal. The outstanding stock of private sector external borrowing stood at around $14 billion in FY18 from $10.53 billion in FY17. The ratio of foreign private borrowing to total external debt further increased to 23 per cent to 25.50 per cent during the above mentioned period.
How external borrowing is creating pressure on the current account may be gauged from the ratio of current account receipts (CAR) to debt. The ratio was 111.60 in FY17 which declined to 103.40 in FY18. As the CAR is covering more than 100 per cent of the external debt, it indicates that external debt is still well managed. But declining trend of the ratio also hints that repayment burden in foreign currency is steadily increasing.
Again current account deficit to Gross Domestic Product (GDP) ratio reached above 3.0 per cent in the past fiscal year. It is likely to come down below 2.0 per cent as per the central bank's projection. This will bring some relief to the external sector.
CORRECTION PATH: The half-yearly BoP situation has provided the economy a better footing for the next half of the current fiscal. It also provides some policy space to manoeuvre the economy to ease its BoP pressure in the coming days. As there is little room to correct the deficits, any attempt of forced correction of deficits will lead to dictate trade patterns in such a way that may distort the market mechanism. Good thing is that deficits are already on the path of correction. Streamlining the internal spending spree will be critical to make it more effective.

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