In the balance of payments, current account includes the balance of trade (recording

exports minus imports of goods) plus the balance on services (recording exports of
services minus imports of services), plus inflows minus outflows of income and
current transfers. Current account deficit occurs when the current account balance has
a negative value, meaning that debits are larger than credits (there is an excess of
debits). Pakistan current account deficit has risen to US$12.12 billion in 2016/17 from
US$4.86 billion in the previous year.

First, it would lead to depreciation, decrease in the value of one currency in terms of
another in a floating exchange rate system or a managed flow exchange rate system.
As Pakistan’s export revenue is lower than import expenditure, more rupees are
exchanged in the foreign exchange market for foreign currencies. Therefore, the value
of rupee to other currency decrease.

rupee

Initially, the exchange rate of rupee is at Ex1, with Q1 amount of rupee traded in the
market. As more rupees are flowing into the market, the supply of rupee increases and
supply curve shifts rightwards from S1 to S2. The new equilibrium exchange rate
decreases to Ex2, with Q2 amount of rupee traded. Hence, rupee depreciates.

This may raise the possibilities of cost-push inflation, a type of inflation caused by a
fall in aggregate supply. As a country highly relying on “imported capital goods”,
which accounts for “32% of its total imports”, rupee depreciation would significantly
increase the production costs among Pakistan producers. Since those capital goods are
“necessary for the growth of SMEs, agricultural, housing and construction”(P2), the
overall price level in Pakistan is expected to rise while the total output produced will
be discouraged.
(dep+highly rely=higher cop. Since important mat, higher p+lower Yp)
It may also lead to speculation, buying or selling currencies in the hope of making
profits. Since rupee is “overvalued by 20%”, while Pakistan is currently implementing
a managed exchange rate system, there is huge possibility that Pakistan will reduce
the targeting range and devaluate rupee since it is lacking foreign reserve and the
room to raise interest rate is limited. If rupee devaluates, speculators will expect
further devaluation considering its worsening CAD situation, and will hence sell
rupee in advance, leading to unstable rupee value. This may discourage international
trade and investment in Pakistan.
In addition, it may lead to lower living standards in the future. Since the government
now faces a “significant budget deficit,” it would have to pay a large bid of borrowing
back. This means the government has to cut expenditures on education or health
sectors, which may reduce the welfare of the future generations, who may suffer from
fewer access to education and medical service. Meanwhile, if the government chooses
to increase income tax, Pakistan people will be less able to purchase necessity and
will be dissatisfied towards the government, leading to social unrest.

It may also degrade Pakistan’s credit ranking. The Pakistan government may have to
“request a new IMF loan” (Para 1), which indicates it has not paid back the previous
borrowing. If IMF agrees to borrow fund to help Pakistan solve the CAD problem, the
government’s indebtedness would increase sharply. As the country is already heavily
indebted, there is higher risk of default, leading to lower international credit ranking,
which would make it more difficult to make future borrowings.

Furthermore, it may force the government to practice painful demand management

policies, including a decrease in government spending or an increase in taxes (or
both). If the income tax rate is constantly set high, consumers would have less
disposable income and consume less, and firms would have fewer after-tax profits and
invest less. Since C and I are components of AD, this action may overturn the
promising economic perspective Pakistan has been enjoying in the past ten year. The
reduction in growth would lead to lower business confidence and discourage
investment in the future.