Dynamics of Current Account Deficit: A Lesson from Pakistan

Abstract

This study investigates the determinants of the current account deficit in Pakistan by using the annual time series data for the period from 1976 to 2010. The cointegration results suggest the positive and significant long run relationship of the current account deficit with the exchange rate, trade deficit and fiscal deficit while a significant negative relationship is found with external debt and private saving. The error correction model also confirms the significant positive relationship of the current account deficit with trade deficit and fiscal deficit in the short run. The Granger-causality test shows the bidirectional causal relationship of exchange rate and external debt with current account deficit. While, unidirectional causality is found from current account deficit to trade deficit and private savings. It is recommended that the government needs to be cautious in financing its fiscal deficit. Savings habits should be increased to narrow the investment gap in economy.