RELATIONSHIP BETWEEN PAKISTAN’S FISCAL &

TRADE DECIFIT
(TWIN DEFICIT)

ARSALAN ISLAM
DATED: 13-12-2010
EMPERICAL THEORY BEHIND THIS RELATION

• KEYNESIAN OPEN ECONOMY MODEL STATES

Y=C+I+G+X-M---expenditure approach---(1)
Y=C+S+T----income appraoch---------------(2)
(X-M)=(S-I)+(T-G)----substitute-----(3)
KEYNESIAN INCOME-EXPENDITURE APPROACH STATES
IN BUDGET DEFICIT

DOMESTIC ABSORPTION

DOMESTIC INCOME LEVEL

IMPORT

EXPORT

TRADE DEFICIT
KEYNESIAN OPEN ECONOMY MODEL WITH HIGH
CAPITAL MOBILITY STATES
IN BUDGET DEFICIT

AGGREGATE DEMAND LEVEL

DOMESTIC REAL INTEREST RATE

INFLOW OF
FOREIGN
CAPITAL

LOCAL CURRENCY

EXPORT
RICARDIAN EQUIVALENCE HYPOTHESIS

• No link between the budget deficit and trade

deficit
• Individuals are concerned about their life time
budget constraints and real wealth. Therefore,
• In future tax rate, if current government
budget deficit increases, current savings
therefore there will be no impact on external
balance and the trade balance would remain
stable.
RELATIONSHIP BETWEEN TWIN DEFICIT

• 2000, aqeel and nishat examined the

Pakistan’s case and they found in short run the
causal effect was found negative between
budget deficit and trade deficit
• However, in long run the causal effect on trade
deficit is positive.
 INTERNATIONAL RELATIONSHIP
• 1993, Rosenswieg and Tallman investigated that in
US economy, government deficit leads to trade
deficit.
• 2005, Basu, Suprana and Datta investigated the fiscal
deficit on India’s external accounts and did not found
existence of twin deficit in Indian economy.
• 2007, Lau and Haw investigated relation between the
twin deficits in Malaysia and Thailand and found
bidirectional relationship between these two deficits
in Malaysia however in Thailand it’s a one-way
causality, from budget deficit to trade deficit.
REASONS FOR HIGH TRADE DEFICIT
• The element of self-reliance lacking in the mechanism of
Pakistan's economy is one major reason as to why Pakistan
has to import goods mainly on heavy prices from other
countries.
• The textile sector constitutes a major part of our exports and
although the exports of Pakistan have increased from before
they still contribute very little to the overall Gross National
Product of the country.
• The main reason is that our government is not educated, over
the year they have not expended their goods to new
destinations.
• The biggest reason for budget deficit Pakistan experiences
is because it's import bills exceed it's exports. Exports are
foreign exchange earners and when we import it actually
takes away our foreign exchange reserves thus creating a
budget deficit. 
• Almost 50% of the import bill comprises of edible oil alone,
now that is an excess which can easily be avoided.
• A mismanagement of resources and funds exists which
further exacerbates the problem.
• The insecure economic air makes it harder for Pakistani
businessmen to conduct businesses and are moving their
investments to other countries. (flight of capital)
• Low quality of domestic goods, so people prefer imported
goods.
• Pakistan's main exports are dependent on the agricultural
goods which are also easily available in the neighboring
countries like Bangladesh and India and Indonesia etc, so even
here Pakistan faces competition,
• Tourism in Pakistan has also been declining due to the
unpopularity and increasing of illegal activities even though
Pakistan has tourist attraction but foreigners fear to come to
Pakistan due to the negative stories they have heard and they
deny to come to Pakistan so therefore Pakistan even suffers
due to less tourists who bring foreign currency of theirs into a
country
REASONS FOR HIGH FISCAL DEFICIT
• High expenses on non development
expenditure.
• Inflationary pressure, decreases the value on
money.
• High expenses on interest payments on loans.
• Increased levels of economic activity.
•  levels of social benefits.
 REPERCUSSIONS ON ECONOMY
• 3% of annual fiscal deficit of GDP is good for a economy
• In Pakistan, the economist expect 6.4% of GDP for 1QFY11
• On the external side, the foreign remittance for the month
October 2010 stood at $855mn,
• Despite the fiscal deficit, the 1QFY11 current account deficit
declined by 7%, YoY to US$545mn.
• The import bill for Oct 2011 stood at $3.22bln while exports
reached to $1.99bln, this trend is good for the economy.
• Higher current account deficit in the long term is not the
concern as long as it matches the foreign inflows in the
foreign direct investment or grants.
• Foreign reserves fell down to $16.85bln.
• The implementation of RGST will not be only
crucial in receiving the next grant from IMF
standby program but it will also boast the
revenue for the government, ultimately raising
the Tax-to-GDP ratio.
• The inflationary digits will fell down from the
January 2011 due to higher base effect and
increased foreign inflows
 CONCLUSION
• It is confirmed that in Pakistan one way
direction causal relationship exists showing
trade deficit positively effecting budget deficit.
• Deterioration in current trade deficit leads to
slower pace of economic growth and hence
increase the budget deficit. Policies effectively
reduce the trade deficit would have a desired
impact on the budget deficit.
 RECOMMENDATION
• HOW TO CONTROL HIGH TRADE DEFICIT
• This is generally accomplished directly through
– import restrictions
– Quotas
– duties (though these may indirectly limit exports as well)
– subsidizing exports
– Influencing the exchange rate to make exports cheaper for foreign buyers will
indirectly increase the balance of payments. This is primarily accomplished by
devaluing the domestic currency
– Adjusting government spending to favor domestic suppliers is also effective.
• Less obvious methods to reduce a current account deficit include
measures that
– increase domestic savings
– reduced domestic borrowing, including a reduction in borrowing by the
national government.