CURRENT ACCOUNTS DEFICITS SUSTAINABILITY: IMPLICATIONS OF INTERTEMPORAL FOREIGN BORROWING CONSTRAINT FOR PAKISTAN

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1 Trakia Journal of Sciences, Vol. 6, No. 3, pp 3-9, 28 Copyrigh 28 Trakia Universiy Available online a: hp:// ISSN (prin) ISSN (online) Original Conribuion CURRENT ACCOUNTS DEFICITS SUSTAINABILITY: IMPLICATIONS OF INTERTEMPORAL FOREIGN BORROWING CONSTRAINT FOR PAKISTAN S. Azgun *, T. Ozdemir 2 Faculy of Economic and Adminisraive Sciences, 2 Faculy of Agriculure, Biomery Geneics Uni, Universiy of Yuzuncu Yil, Van, Turkey ABSTRACT Theory of ineremporal budge consrains is applied o curren accoun deficis of Pakisan for 98:- 24:2 periods. The aim of his sudy is o demonsrae wheher he foreign deb arising from defici curren accouns policies has susainabiliy in he curren economic policies of Pakisan. By means of he revenues and expendiures of curren accouns, i is esed if curren accoun deficis are oo large. The resuls obained have demonsraed ha curren accoun deficis are no susainable. Key words: curren accoun defici, solvency condiion, ineremporal foreign budge consrain, coinegraion. INTRODUCTION Susainabiliy refers o he willingness and capabiliy of a counry o be able o pay is curren and prospecive public and foreign deb liabiliies [] While he public deb sock increases o he same exen wih he budge defici in he curren year, he foreign deb sock increases o he same exen wih he curren accoun defici. In his conex, he susainabiliy of he public debs and budge deficis mean he same, as he susainabiliy of curren accoun deficis mean he same wih he susainabiliy of he foreign debs [2]. In he lieraure, models have been esablished for primary deficis, he public debs and hese models have been adaped o he curren accoun deficis. There are wo essenial approaches in he lieraure wih regard o susainabiliy: accouning approach and he presen value approach [3]. The firs approach encompasses he effors carried ou wihin he conex of poor counries wih heavy debs in order o deermine he reasons for he global deb crisis, reduce global povery, improve he income disribuion and develop susainabiliy merics wih he suppor of he inernaional * Correspondence o: Assis. Prof. Sabri Azgun; Faculy of Economic and Adminisraive Sciences, Universiy of Yuzuncu Yil, 658, Van, Turkey; E- mail: sabriazgun@gmail.com communiy. The second approach includes he effors performed by he academic circles via relaively wider applicaion of economeric echniques. The superioriy of he presen value approach o he accouning one is ha i can be implemened for boh he developed and developing counries and ha i offers esable proposiions, as well. This approach examines he problem of deficis from a differen poin of view insead of he magniude of any deficis a any poin in ime. The presen value approach deermines he susainabiliy of he deb based on he condiion of iner-emporal repaymen capabiliy which measures he presen value of he deb. Acually, he repaymen capabiliy condiion is he phenomenon of he execuion of he curren economic policy by aking ino consideraion he presen value borrowing consrain. If he governmen provides adequae budge accoun surplus for he fuure in order o pay for he accumulaed foreign deb and ineress, hen i fulfils he presen value foreign borrowing consrain. Conversely, he oal amoun of expendiures incurred by he curren regnum, expressed wih he erm 'presen, and he expeced primary foreign regnum should no increase he oal amoun of he discouned revenues obained from he foreign regnum. In ha Trakia Journal of Sciences, Vol. 6, No. 3, 28 3

2 conex, he presen value borrowing consrain (or he repaymen capabiliy condiion) is deermined by he revenue obained from he primary foreign regnum and he roue o be followed by he expendiures incurred by he foreign regnum [4]. If hese wo variables do no ac ogeher in he long erm, he governmen shall have an increased risk in is inabiliy o pay back is deb. The menioned consrain, which can be called he iner-emporal borrowing consrain is he echnical crierion on wheher he implemened curren governmen policy shall have a curren accoun surplus ha will be enough o pay back he accumulaed foreign debs and ineress if he policy implemened by he governmen is causing foreign accoun deficis. The essenial sudies on he menioned consrained were performed by amilon and Flavin [5], Wilcox [6], Trehan and Walsh [7], akkio and Rush [8]. Taking he proposiions of hese sudies as basis, Baglini and Cherubini [9], Tanner [4], Ahme and Rogers [], Caparole [], Bohn [3] implemened he iner-emporal budge consrain heory o he public deficis and curren accoun deficis of many counries. This sudy is composed of five secions. The firs secion lays down he lieraure. The second secion explores he iner-emporal budge consrain heory for he curren accoun deficis. The hird secion examines he condiion for repaymen capabiliy and coinegraion ess. The fourh secion includes he analysis performed and he fifh secion presens he resuls obained. INTERTEMPORAL FOREIGN BUDGET CONSTRAINT The governmen is faced wih a foreign budge consrain during every erm. The foreign budge consrain faced by he governmen every erm is expressed in he following way: IM ( r) F = F 4 F () In he equaion above, refers o he promissory noes issued by he governmen o he foreign marke o provide funds. In he relevan periods, i is assumed ha he expored promissory noes all have he same IM mauriy. indicaes he expendiures ha he governmen incurs in he foreign regnum for goods and services procuremens and he expendiures for ransfers o he foreign regnum, he indicaes he revenues obained from he foreign regnum by means Trakia Journal of Sciences, Vol. 6, No. 3, 28 AZGUN S., e al. of goods and services exporaion and he ransfers acquired from he foreign regnum. r As for, i denoes he real ineres raio during he erm. The lef hand side of he equaion specified as () refers o he expendiures incurred by he governmen o he foreign regnum during he erm, while is righ hand side indicaes he revenue ha he governmen obained from he foreign regnum during he same erm. The variables in he equaion (), which expresses he foreign budge consrain ha he governmen faces during any erm can be expressed in nominal or real erms, while hey can also be normalized by being divided by he populaion or GDP. A his poin, wheher he ineres raio in he equaion number () shall be aken as nominal or real depends on how he revenues and expendiures are expressed. When he variables are expressed in nominal erms, he nominal ineres rae should be used; in real erms, he real ineres rae can be used. 2 When he variables are expressed in he r form of real GDP per person, expresses real ineres rae - growh rae per person and r he refers o he real ineres rae populaion growh rae when he variables are expressed per person. The budge consrain for he erm specified in he equaion () is applicable o all he i ( i =,2, L ) erms. If his expression is prospecively exrapolaed for he erms, 2, 3, he ineremporal foreign budge consrain of he governmen shall be obained: Fo = r ( IM ) limrn = (2) In his expression, i is defined as: Fs = r = s F s r ve s The mos imporan elemen in he ineremporal foreign budge consrain specified in he equaion (2) is he las erm expressed lim rn as on he righ hand side of he equaion. Once his limi is equal o zero, lim rn namely, i is =, he iner-emporal budge consrain expresses ha he promissory noes sock is equal o he presen 2 In he relevan lieraure, i is frequenly assumed ha he real ineres raes are fixed. I is no really realisic o assume ha he nominal ineres raes are fixed.

3 value of he curren accoun surpluses. The fac ha his limi is no zero means ha he governmen has finances in he curren accoun defici by exporing new promissory noes. I is no possible for he governmen o mainain for a long ime his siuaion which is ermed he Ponzi finance. In oher words, he foreign deb canno grow forever a a rae higher han he real ineres rae. This siuaion is expressed as he unsusainabiliy of he curren accoun defici. Effors are aken o deermine wheher he curren policy is susainable by aking as basis he periods when similar policies were implemened, wheher he presen or shor-erm curren governmen policy is susainable. Thus, i is invesigaed wheher he daa of a period when a specific economic policy is implemened are harmonized wih he lim rn condiion =. Supposing ha he variables and E are sochasic processes, he expeced value for he limi specificaion for susainabiliy has o be equal o zero. Conversely, fulfilling he condiion E lim r F = [ ( n n )] denoes ha he curren policy is susainable. The iner-emporal foreign budge consrain (2) is wrien as in he equaion; however, his expression is empirically no suiable for he susainabiliy condiion o be esed. On he oher hand, i is possible o obain an economerically esable expression from he Equaion () via a couple of algebraic adjusmens. For his purpose, i should be assumed ha he ineres raes are fixed and ha he uncondiional expeced value is equal o r [8]. The assumpion abou being fixed is no realisic for he nominal ineres raes. This assumpion can only be made for real ineres raes. This necessiaes he enire model o be expressed in real erms as in his rb sudy. () if is removed from boh sides of he equaion, he following expression is obained: E ( r) F ) = F (3) In his expression, i is defined as E = IM ( i i) F. To be able o obain a esable, alernaive equaion, he equaion number (3) derived from he equaion number () is exrapolaed o reach he following expression: = F j β J J limβ J J= j! ( E ) F j (4) AZGUN S., e al. β = ere, i is defined as ( i). If he variables and E of he equaion (4) are rearranged by being expressed in he form of he primary differences, i can be wrien as follows: E rf = β J= J ( E ) lim F j (5) The lef side of he expression given in he equaion (5) indicaes he expendiures incurred for goods and services procuremens from he foreign regnum, he expendiures for ransfers obained from he foreign regnum and he deb ineres paymens. The empirical sudies performed have shown ha he variables and E followed he accumulaive random walks wih drif [8]. Deparing from his poin of view, if i is supposed ha he level values of variables and E are no fixed, however, heir primary differences are fixed and i is defined MM = IM r as F, he equaion number (5) can be wrien again in he following way: j MM = α lim β ε J (6) ere: α β j ( α α 2 ) ( r) = r ( α α2), j ε = β ( α α2 ) and are how i is defined. I is acceped ha he limi of he final erm in he equaion number (6) is close o zero in infiniy. If his accepance is no aken, hen a siuaion emerges where he deb can be cycled via deb ill infiniy. Such a siuaion does no comply wih no only he economic raionaliy, bu also he economic ineress of he economic unis (lenders and borrowers) supposed o ac raionally. If he final erm in he equaion no. (6) is equal o zero, he menioned equaion can be wrien in he form of regression equaion as follows: = a bmm ε (7) The regression equaion number (7) consiues he basis of he hypohesis which shall be esed. The null hypohesis o be esed is ha he co-efficien b is equal o one, ε and he residual variable is fixed. Conversely, if he series MM and are no fixed, he null hypohesis is ha he coefficien b is one and also ha he variables MM and are co-inegraed. When he series MM and are no fixed, i is no obligaory Trakia Journal of Sciences, Vol. 6, No. 3, 28 5

4 for he co-efficien b o be equal o one [4]. When he variable MM is no fixed while he variable is fixed, he series MM shall show a endency o increase while he series shall exhibi a endency o be fixed. Thus, he coefficien b will converge o zero in he infiniy and here shall be no long-erm relaion beween hese wo series. In ha case, he conclusion ha he iner-emporal budge consrain has been violaed can be reached inuiively. owever, hen he series MM and are co-inegraed and <b<, he hird erm on he righ side of he equaion no. (6) shall converge o zero in infiniy, hence ineremporal budge consrain shall be ensured. SOLVENCY CONDITION AND COINTEGRATION Co-inegraion is a concep which is relaed o ime series ha are no fixed. The linear combinaions of ime series ha are no individually linear can be fixed. The variables ha have a co-inegraion relaionship among hem ac ogeher in he long-erm. Conversely, here is a relaionship of balance among hem. To ensure he condiion of susainabiliy in he equaion no. (7), here should be a relaion of co-inegraion among he variables based on he presupposiion ha hey are no fixed. Wihin he scope of curren accoun deficis ha consiue he subjec of he sudy, he presupposiion shall be made ha he series MM and are no fixed. In such a case, he linear combinaion of series MM and in he form of amm = v is no generally fixed, eiher. On he oher hand, he series MM and may have a coefficien b which renders fixed a linear combinaion like amm = u b. In his sudy, he Engle-Granger and Johansen co-inegraion ess shall be used o deermine wheher he variables are coefficien or no. Wihin he framework of he saemen specified in he equaion (7), he coinegraion es consiss of wo phases. The firs sage is o subjec he variables and MM o he uni roo es o deermine wheher each one is co-inegraed a he primary level I(). As a second sep, he variable MM is subjeced o regression over he variable (or he variable over he variable MM). Then, uˆ = he equaion βmm is esed by means of uni roo es. If he variables and MM are co-inegraed, uˆ = he regression equaion βmm, AZGUN S., e al. namely, I(), shall be fixed. On he oher hand, if he variables and MM are no coinegraed, he error erm u is no fixed. Since he uni roo ess are implemened on he residuals as u, he hypohesis is expressed as here is a uni roo or he error erm u is no fixed. Thus, he null and alernaive hypohesis in he co-inegraion ess are expressed as follows: o : he error erm u is no fixed and he variables MM and are no co-inegraed. : he variables MM and are coinegraed. As expressed above, he null hypohesis wihin he scope of co-inegraion ess is mosly composed as a lack of co-inegraion relaions. In oher words, i is assumed ha here are no co-inegraion relaions beween he variables and MM. In ha case, he null hypohesis will be applicable if no srong evidence o rejec a null hypohesis can be reached. Johansen co-inegraion es is an exended and developed version of he Engle- Granger Mehod and i provides possibiliy for making a co-inegraion analysis among wo or more variables. The bigges advanage of Johansen co-inegraion analysis is ha i provides possibiliy for making a coinegraion analysis among variables wihou making any disincions as inernal-exernal. I can be expressed as a VAR (Vecor Auo regression) model consising of n number of variables and n number of equaions, which shall be subjeced o coinegraion analysis. In such an equaion sysem, here can be a mos n- number of equaion relaions. These co-inegraion relaions are echnically expressed as co-inegraion vecors. In ha case, here shall be a mos one co-inegraion vecor in he model consising of wo variables ( and MM) as in he equaion no. (7). owever, if he equaion sysem includes a rend variable, he number of variables shall be hree, hence here will be able o be wo co-inegraion vecors. The number of coinegraion vecors is ermed as he coinegraion rank (r). Thus, he null and alernaive hypoheses ha shall be formed o es he equaion no (7) wihin he scope of Johansen co-inegraion es can be expressed as follows: : r = : r > 6 Trakia Journal of Sciences, Vol. 6, No. 3, 28

5 If he hypohesis canno be rejeced, he variables and MM are no co-inegraed. In ha case, he condiion for repaymen capabiliy has no been fulfilled. On he conrary, if he hypohesis is rejeced, he fac ha he variables and MM are coinegraed, namely, he repaymen capabiliy, shall indicae he resul ha he debs are susainable. ANALYSIS AND FINDINGS In he sudy, he 98-Q period of Pakisan is aken as he sar period and he duraion ha elapses from he period a sake ill he Table : ADF (Augmened Dickey-Fuller) Tes Resuls AZGUN S., e al. year 24 is examined based on quarerly daa (98Q 24-Q2). The daa used in he sudy were obained from he OECD daabase. While denoes he curren accoun revenues obained by means of goods and services exporaion and he ransfers received from he foreign regnum, MM expresses he goods and services imporaion expendiures and ransfer expendiures performed by he governmen o he foreign regnum including he MM ineres. Since he daa obained are in he form of dollars, no adjusmen is needed o express i as a real variable. Variable Trend ADF es Saisics Criical Values* Lag** NA NA MM NA MM NA SA NA SA NA MMSA NA MMSA NA * To rejec he hypohesis (Uni roo available) according o he level of significance (5%) McKinnon criical values. ** Indicaes he delays according o he SIC crieria. In his sudy, wheher he iner-emporal budge consrain has been fulfilled or no has been esed hrough he use of Engle-Granger and Johansen Co-inegraion mehods. Boh ess were also performed via he eliminaion of seasonal flucuaions in he series. The prefix SA was added before he relevan variable o indicae every seasonal flucuaion. The seasonal flucuaions were eliminaed using he E-views 5 package program by means of mehod. The special resuls performed wih and wihou he eliminaion of seasonal flucuaions are given on Table 2 and Table 3. Before esing wheher he revenue and expendiure series of curren accoun revenue and expendiure are coinegraed, i is necessary o es wheher hese variables are individually co-inegraed a he firs degree, namely, wheher hey are fixed. The ADF uni roo es has been used o es wheher he variables are fixed. The resuls obained from he ess on being fixed are specified on Table. Since he rend variable was no found o be saisically significan in any of he ADF models ha were esed, hey were removed from he models. All he models conain fixed erms. For deecing he delay values, he AIC and SIC crieria were used. On Table, he resuls in which he delays obained via SIC crierion are presened. In his char, he es saisics in which he null hypohesis was rejeced are specified in bold characers. I can be seen on he Table ha he curren accoun balance revenue and expenses are no fixed on level values; however, he primary differences of hese variables are fixed. In ha case, i is necessary o have a relaion of co-inegraion beween he variables and MM in order o fulfil he iner-emporal repaymen condiion. To deec a possible co-inegraion relaion, Engle-Granger and Johansen coinegraion ess were used. The summary resuls of he co-inegraion es performed using he mehodology Engle-Granger is specified on Table 2. Judging by he firs par of Table 2, i can be seen ha he hypohesis ha he residues derived from he regression = α ˆ α MM uˆ ˆ has a uni roo canno be rejeced in he ADF es. The resul ha he variables and MM are no coinegraed for he model in quesion is derived from here. In oher words, i is concluded ha Trakia Journal of Sciences, Vol. 6, No. 3, 28 7

6 he iner-emporal repaymen capabiliy condiion canno be fulfilled in he coinegraion ess acualized by using he Engle-Granger mehodology. To deec he co-inegraion relaion beween he variables AZGUN S., e al. and MM, he Johansen co-inegraion rank es was also implemened o compare wih he resuls obained via Engle-Granger mehodology. Table 2: Co-inegraion Tes of Engle-Granger Model: ˆ ˆ MM = α α α α uˆ Criical Value* ADF Tes Saisic Model: SA = ˆ α ˆ α α α MMSA Criical Value* ADF Tes Saisic * McKinnon criical values o rejec o hypohesis (Uni roo available) (5%). Table 3: Co-inegraion Rank Tes of Johansen Variables λrace Criical Value (5%) and MM r = r > SA and SAMM r = r > The es resuls were obained according o he 5% confidence inerval. The resuls obained from Johansen es are summarized on Table 3. As can be seen in he char, he hypohesis r = canno be rejeced for eiher model. This means ha here is no co-inegraion vecor. To sum up, he resuls obained from he ess performed using Engle Granger and Johansen mehodologies indicae ha he curren accoun revenue and expendiure series for Pakisan are no coinegraed. RESULTS The governmens, which have heir essenial aim as achieving he poenial produc level engage in economic relaions wih foreign counries. One of he fundamenal objecives of he foreign rade policy is o keep he curren accoun deficis occurring as a resul of hese economic ransacions a a reasonable level. This siuaion requires ha wheher he curren accoun deficis are very wide be deermined by means of he iner-emporal repaymen capabiliy condiion. In oher words, i is wheher he curren foreign rade policy conduced by he governmen causes foreign rade deficis ha are oo large o be conduced presenly and in he near fuure. In he sudy, he iems of he curren accoun balance shee ha earn and lose foreign asses have been esed via Engle- Granger and Johansen co-inegraion mehods o deermine wheher he curren accoun deficis in Pakisan for he erm :Q 24:Q2 are susainable or no. The resuls obained indicae ha he iner-emporal foreign budge consrain deermined in he equaion no. (7) has no been fulfilled. Conversely, i is seen ha he curren accoun revenues and expendiures do no feaure a progress in he same wavelengh in he presen value erms as of he period 98:Q 24:Q2, which has been seleced as he period o be sudied. ence, he iner-emporal repaymen capabiliy condiion canno be fulfilled. I can be concluded ha he curren foreign rade policy is no susainable so long as here are no imporan srucural policy changes in near fuure based on he failure o fulfil he repaymen capabiliy condiion as of he sudied period. REFERENCES. Krugman, P., Financing vs. Forgiving a Deb Overhang, Journal of Developmen Economics, 29: , Azgün, S., Foreign Deb Susainabiliy: Tess of Ineremporal Budge Conrain. 8 Trakia Journal of Sciences, Vol. 6, No. 3, 28

7 Anadolu Universiy Journal of Social Sciences, 5(2): 57-68, Cuddingon, J. T., Analysing he Susainabiliy of Fiscal Deficis in Developing Counries, World Bank Policy Research Working Paper, #784, Quinos, Carmela E. (995) Susainabiliy of Defici Process wih Srucural Shifs. Journal of Business & Economic Saisics, 3(4) amilon, J. D. and Flavin, M. A., On he Limiaions of Governmen Borrowing: A Framework for Empirical Tesing. The American Economic Review, 76(4): 88-89, Wilcox, D. W., The Susainabiliy of Governmen Deficis: Implicaions of he Presen-Value Borrowing Consrain. Journal of Money, Credi and Banking, 2(3): 29-36, Tanner, E. and Liu P., The Budge Defici Too Large Some Furher Evidence. Economic Inquiry, 32:(3): 5-58, akkio, C. S. and Rush. M., Is he Budge Defici Too Large? Economic Inquiry, 29 (3): , 99. AZGUN S., e al. 9. Baglioni, A. and Cherubini U., Ineremporal Budge Consrains and Public Deb Susainabiliy: The case of Ialy. Applied Economerics, 25: , Ahmed, S. and Rogers J.., Governmen Budge Deficis and Trade Deficis Are Presen Value Consrains Saisfied in Long-Term Daa?. Journal of Moneary Economics, 36(2): , Caparole, M. G., Bubble Finance and Deb Susainabiliy: a Tes of he Governmen s Ineremporal Budge Consrain. Applied Economerics, 27: 35-43, Trehan, B. and Walsh, C. E., Tesing Ineremporal Budge Consrains: Theory and Applicaions o U.S. Federal Budge and Curren Accoun Deficis. Journal of Money, Credi and Banking, 23(2): , Bohn,., The Behavior of U.S. Deficis Public Deb and Deficis. Quarerly Journal of Economics, 3: , 998. Trakia Journal of Sciences, Vol. 6, No. 3, 28 9