Sunday, January 16, 2011

Why the current account deficit?

Here is my answer to the second reader question, as part of the reader appreciation weekend. But let me remind you the question first:
Can you tell me why people are so focused on the current account deficit figure? If the underlying worry is the potential destabilising effects of hot money and short term borrowing then why doesnt' everyone simply focus on metrics that track those figures? Is it because CAD is a more readily available/computable figure or is it because of some other reasons drive why CAD is so important to focus on? Any comments/insight you got on this would be highly appreciated.
Now, compared to the previous question, this is something I know one or two things about. I will address the question in three steps, going from the general to more detailed:

First, I understand the reader's point. If you care about the CAD because of financing concerns, why not concentrate on these financing concerns rather than the CAD. This makes sense, but you'd still need something to gauge the financing with. Say, if Turkey attracted USD 10bn of portfolio flows during the past year, is this too little and too large? Compared to what? That's why you also need the CAD. In fact, that's why we call the both of them (and reserve accumulation, which is the difference between the two) the Balance of Payments, or BOP. And of course not all items under the CAD headline number are created equally. For example, if I am forecasting the CAD, I would spend much more time with exports and imports; it is pretty straightforward the to project the only other major item under the current account, tourism revenues, and the other items are way too small to make a difference.

But these are only accounting identities. If you want to go beyond mere accounting, you have to know how the different sectors of the economy work. For example, a great deal of the banks' short term borrowing, or well short-term capital flows in general, is related to the banking sector's lira liquidity gap. Since covering the liquidity gap just by borrowing abroad and selling FX would bring in a currency mismatch (besides, BRSA, the banking regulator, has open-position limits), it makes sense for the banks to access the hot money parked in the money market via swap operations and then extend it via credit. BTW, that's why the CBT is so fixated on credit growth and and making the country less attractive to short-term capital flows: If no capital flows, no swaps that end up as credit. If no credit, no surging imports. If no surging imports, no ballooning CAD. Yep, it is as simple as that...

Or if you want to know the reasons behind the current account gap, you would have to know about the country's private savings gap. My hands are starting to hurt, so just read the column, but the main point is that controlling the CAD is no easy task...

3 comments:

Alper said...

Fantastic answer also providing good context of the current dynamics in Turkey. Thank you!

Emre Deliveli said...

I am glad it was useful; one small disclaimer: I should have said funding rather than liquidity gap. I meant the difference between credits and deposits, or the credit deposit ratio. Since banks can't increase their deposits as fast as credit, they have to resort to other means of funding...

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