| Date | May 2019 | Marks available | 8 | Reference code | 19M.2.HL.TZ0.2 |
| Level | Higher level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Discuss | Question number | 2 | Adapted from | N/A |
Question
Current account deficit poses a challenge to Pakistan’s economy
- The president of Pakistan has expressed his concern at the significant increase in Pakistan’s current account deficit. The current account deficit grew to US$12.12 billion in the fiscal year of 2016/17 compared to US$4.86 billion in 2015/16. The deficit was caused by rising imports and falling exports. The increasing current account deficit may result in Pakistan having to request a new International Monetary Fund (IMF) loan to fund the deficit. To avoid this, the president is proposing that the importing of luxury, non-essential items needs to be reduced.
- The governor of Pakistan’s central bank agreed with the president’s concern. He said that the “rapidly growing current account deficit is the biggest challenge facing the country’s economy”. He agreed that the problem is made worse because many non-essential imports are being purchased, which requires borrowing from abroad. However, he stressed that while rising non-essential imports are a problem, “32 % of imports are capital goods” and are necessary for the continued growth of small to medium enterprises (SMEs), agriculture, housing and construction.
- Central bank advisors have also recommended depreciating the rupee (Pakistan’s currency) to reduce the trade deficit. The value of the rupee is currently controlled through a managed exchange rate system. It has been suggested that the rupee is overvalued by as much as 20 %. However, the central bank governor claims that a “depreciation has a number of negative effects”.
- In 2016, Pakistan’s economic growth reached 5.3 %, its highest point for 10 years. The government has estimated that it will be 6 % in 2017. According to the central bank governor, loans to SMEs are currently only 7 to 8 % of all loans to businesses in Pakistan. He believes that if loans to SMEs were increased to 15 to 17 % of all loans to businesses in Pakistan, there would be even higher economic growth.
- Along with the current account deficit, fiscal policy decisions have also led to a significant budget deficit. The budget deficit increased in 2016, resulting in greater public debt. The central bank recommends the government’s debt to be limited to 60 % of gross domestic product (GDP).
[Source: adapted from Current account deficit may lead to IMF loan: FPCCI chairperson, https://www.thenews.com.pk/
print/226102-Current-account-deficit-may-lead-to-IMF-loan-FPCCI-chairperson and Current account deficit poses biggest
challenge to economy: SBP, https://www.thenews.com.pk/print/225481-Current-account-deficit-poses-biggest-challenge-toeconomy-
SBP. Copyright © The News International, Karachi, Pakistan.]
List two functions of the central bank (paragraph [2]).
Define the term fiscal policy indicated in bold in the text (paragraph [5]).
Using an exchange rate diagram, explain how the central bank might depreciate the value of the rupee (paragraph [3]).
Explain the difference between a current account deficit and a budget deficit (paragraph [5]).
Using information from the text/data and your knowledge of economics, discuss the effects of the increasing current account deficit on Pakistan’s economy.
Markscheme
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
Candidates whose explanation does not correspond to the diagram (eg the candidate explains increase of supply, but the diagram shows decrease of demand) can be awarded a maximum of [2].
For an exchange rate diagram, the vertical axis may be labelled exchange rate, price of rupee in terms of another currency, another currency per rupee, another currency/rupee. The horizontal axis should be labelled quantity (of rupees). A title is not necessary.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond level 2 if the answer does not contain reference to the information provided.
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors, or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Responses may include:
- definition of current account deficit (paragraph [1]) / reference to (c).
Positive effects:
- imports of capital can lead to increased economic growth in the long run (paragraph [2])
- high imports of non-essential goods may indicate development and higher living standards (paragraph [1]) suggests consuming outside of PPC
- Pakistan may have to depreciate the currency as advised by central bank. This will reduce the relative price of exports and may allow to improve Pakistan's export competitiveness (paragraph [3]).
Negative effects:
- may require “new IMF” loan and conditions that are attached regarding austerity (paragraph [1])
- persistent trade deficit may compromise “decade high” economic growth (paragraph [4])
- inflows on financial account increase, meaning foreign debt payments will increase and worsen current account deficit
- downward pressure on the exchange rate requiring use of foreign exchange reserves to maintain managed float (paragraph [3])
- may be forced to “depreciate” the rupee which will:
- increase import prices and may cause cost-push inflation
- reduce export revenues – Marshall-Lerner condition
- IMF loans to finance current account deficit (paragraph [1]) will require interest payments that may worsen the budget deficit (paragraph [5])
- foreign investors may be purchasing Pakistan assets to finance the deficit which could threaten sovereignty
- current account deficit may worsen Pakistan’s credit rating
- it may be unsustainable to finance the current account deficit by borrowing. If foreign investors lose confidence, there may be a rapid outflow of financial capital resulting in a rapid fall in the value of the rupee
- fiscal policy (paragraph [5]) decisions may have to be addressed to help with the deficit. In this case, moving from expansionary to contractionary. This may reduce economic growth.
Any reasonable discussion.
To reach level 3, students must be aware of the particular situation in Pakistan, not just present an evaluation of a current account deficit in general.
Examiners report
Most candidates defined the term accurately.
Generally accurately defined.
There some excellent answers to this question with good, clear and accurately labelled diagrams coupled with a concise explanation. Most candidates explained the depreciation in terms of increased supply of rupees. A minority explained it in terms of decreased demand for rupees. Both were acceptable.
Weaknesses: incorrect labelling; failure to explain how the central bank might increase the supply of rupees (decrease demand); and a confusion between internal and external money supply.
In many cases a current account deficit was only partially explained. Candidates often defined the current account in terms of the balance of trade only. Also, the current account was explained in volume terms rather than value.
Budget deficit was generally well understood and defined accurately
This question posed problems with many candidates focusing on how to reduce a current account deficit rather than on its consequences. Those that did attempt to discuss the effects did so superficially. Other candidates attempted to interpret the question in terms of exchange rates. While there was some relevance, such an approach was too narrowly based. The few candidates that did attempt to examine the effects often produced unbalanced answers with very few identifying any positive effects for Pakistan.
