Beneath the balance of payments numbers

The latest balance of payment data released by the Bangladesh Bank (BB) cause a mixture of comfort and caution.

The comfort first  

The current account deficit in July-May last fiscal year amounted to $4.37 billion, 15% lower than the deficit in the corresponding period of FY19. The current account deficit improved despite a rise in trade deficit from $15 billion in July-May FY19 to $16.1 billion in July-May FY20.  

The trade deficit increased because of an 18.2% decline in merchandise exports which overwhelmed the 10.8% decline in merchandise imports. Yet the current account deficit decreased because of a lower deficit in the services account as payments for services fell by $176 million while receipts increased by $42 million.  However, the most important reason was the 8.8% growth in remittances from Bangladeshi workers abroad.

The deficit in the current account was more than offset by $5.4 billion surplus in the capital and financial account.  This was driven by 47% decline in "Trade Credit" and a $1.4 billion turnaround in "Errors & Omissions" from $793 million outflows in July-May FY19 to $563 million inflows in July-May FY20. 

Trade credit represents outflows or inflows on account of the short-term debt of the state-owned enterprises and the difference between customs and actual transactions record which are entered in this account, for instance, the difference between the shipment values of exports and actual receipts.  This difference shrinks as exports decline.

The errors & omissions represent the discrepancy between the financial and capital account and the current account balances.  The exact causes of this discrepancy are generally hard to trace except that they often result from imperfections in sources of data, compilation of the balance of payment accounts, and random factors.  They warrant deeper digging whenever the required size of the entry becomes unusually large both in magnitude and change in direction (outflows abruptly turning into inflows or vice-versa).

Be that as it may, the bottom line is that the overall external balance improved from $682 million deficit in July-May FY19 to $1.63 billion surplus in July-May FY20.  This contributed to increasing foreign exchange reserves held by the BB and the commercial banks. 

Now the caution

The comfort derived from above becomes a little disconcerting from a deeper look at the recent trends.  The current account had a $260 million surplus in July-August 2019.  This turned into a $765 million deficit by end-September and never looked back.  Since then the deficit has grown each month (with the sole exception of January 2020), reaching $4.4 billion in May.  Increase in trade deficit due to accelerated decline in exports and rapid deceleration in remittance growth from March onwards were the key contributors to the rise in the current account deficit. 

Financing the rise in deficit has not been a problem so far. Multilateral loan disbursements picked up by $1.6 billion since February while outflows on account of trade credit declined by $745 million in April-May (reflecting sharp declines in exports) relative to outflows in July-March.  Errors & omissions turned sharply from $679 million outflows in July-April to $563 million inflows in May, a turnaround of $1.2 billion in just one month! 

It is not clear what caused such a quick reversal of outflows into inflows.  The money brought informally by returnee migrants may be one reason, but surely these deserve some explanation in at least a footnote in the BOP data release.  Hopefully, BB is listening.  

The upshot from above is the need for continued vigilance in this time of unprecedented crisis in which external balance is highly vulnerable. Foreign exchange reserves have been boosted recently by one-off increase in budget support disbursements from the ADB, IMF, AIIB and IDB.  There was one from WB in June.  Leaving them out reveals a sharp fall in disbursements from the project aid pipeline, reflecting slowdown in the implementation of aided projects in the Annual Development Program of the government.  The invasion of the coronavirus has been a factor in slowing implementation, but not the only one.

The growth in the current account deficit is likely to persist for a while.  Accessing additional sources of concessional foreign financing will be key to averting pressure on reserves. It is important to maintain sufficient reserve coverage at around five months of imports of goods and services, given heightened risks posed by the economic consequences of Covid-19.  

This will help preserve market confidence. It will increase the economy's ability to withstand the large uncertainties relating to the duration of the pandemic and its impact on major sources of foreign exchange. Uncertainties arising from the virus shock require stronger reserve buffers compared with less uncertain times. This is also the time to allow greater exchange rate flexibility to buffer the economy against external shocks without depleting reserves unnecessarily.