Current account deficit across South Asia: A Second Generation Methodological Adaptive Approach

• Published date: 01 May 2022
• Author: Muhammad I. Shah
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2475

ACADEMIC PAPER

Current account deficit across South Asia: A Second

Generation Methodological Adaptive Approach

Muhammad I. Shah

Research Division, Centre on Integrated Rural

Development for Asia and the Pacific, Dhaka,

Bangladesh

Correspondence

Muhammad I. Shah, Research Division, Centre

on Integrated Rural Development for Asia and

the Pacific, Chameli House, 17 Topkhana

Road, Dhaka 1000, Bangladesh.

Email: ibrahimecondu@gmail.com

Current account deficit poses a serious threat for a country's macroeconomic stability

despite the fast economic growth. The primary objective of this paper is to explain

and critically examine the determinants of current account deficit across seven South

Asian countries using yearly data for 1980–2016 period. This paper employed several

econometric techniques such as cross-sectional dependence to see if shocks that

occur in one country affect another, panel unit root test to check the stationary of

the data and Panel cointegration test to check long-run relationship among the vari-

ables. This study also implemented Continuously Updated estimation procedure

given to estimate long-run coefficients. The findings suggest that an appreciation of

real effective exchange rate leads to a reduction in current account deficit, contrary

to popular belief. The analysis also reveals that financial development, trade open-

ness, fiscal balance and population growth have positive and significant relationship

with current account deficit in South Asia but net foreign asset negatively affects

current account deficit. This study, therefore, has several policy implications for

South Asian countries.

1|INTRODUCTION

Global economy might be enj oying rapid economic growth than ever

before, yet it is passing through a troublingly confusing period. This

is because of the global imb alances created by the lar ge current

account deficit acros s the countries. Even the major advanced econ -

omies are facing large current account imbalances with the continu-

ous rise in public debts. Policymakers and researchers around the

world are now therefore h ighly concerned with the gl obal imbal-

ances arising from the lar ge current account deficit. Current accoun t

deficit poses a serious thr eat for a country's macroeconomic stability

despite the fast econo mic growth. Currency cr isis, weakening of

export competitiveness and increase in external debts are just some

of the problems that might ar ise from persistent curr ent account

deficit.

Growing current account deficit generates high unemployment

and poverty. Maintaining a healthy external balance is therefore

important, be it a developed country or a developing one. Since the

1980s, current account deficit has been a prominent and regular fea-

ture of South Asian economies. The persistent deficit over the years

has undermined the growth of this region and thus reduced the stan-

dard of living of its people. These economies are suffering from count-

less micro and macroeconomic problems manifested mainly by the

imbalances in current account. Faced with sluggish economic growth

and lower standard of living compared to other regions, South Asian

economies rely mostly on foreign aid and investment to boost up their

growth, thereby making itself vulnerable to external shocks. They are

also characterized by the stagnant trends of their export sectors. With

this existing pace of current account deficit, balance of payment crisis

is the most obvious outcome. Sometimes the countries become so

vulnerable that they require IMF bailout. As of 2018, Pakistan is now

seeking its 13th bailout to deal with the current account deficit that is

threatening to trigger a balance of payment crisis. As Figure 1reveals,

economies in South Asia have been running current account deficit

since the 1980s. The fluctuations in Bhutan's current account balance,

however, are higher compared to the other countries of this region.

This has been the case since the 1980s for Bhutan. However, most of

the economies are running current account deficit still today. Even

today, Bhutan's economy is suffering from current account deficit of

more than 20% of the country's GDP.

Received: 28 July 2020 Revised: 6 September 2020 Accepted: 7 September 2020

DOI: 10.1002/pa.2475

J Public Affairs. 2022;22:e2475. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of8

https://doi.org/10.1002/pa.2475