Sustainability of Current Account and Trade Deficits in Transition

Abstract

Trade deficits are caused by the balances between saving and investment and the effects of those balances on international flows of capital. Generally, there are three primary sources of the trade deficit: a decline in saving/GDP ratio; fluctuations in the business cycles; investment opportunities in the country. Generally, less sustainable or unsustainable CA deficits in transitional countries are the consequence of either a fall in savings or an increase of investment; these two events might be determined by a sharp increase of imported consumption goods (substitution of savings by consumption), by a real appreciation of the domestic currency that leads to the loss of competitiveness, or by the weakness of banking and financial systems that are unable to cope with large capital flows. The current Foreign Trade policy of Serbia and Montenegro, aimed to protect its domestic economy from excessively high imports, is economically ineffective. Both consumers and producers prefer to buy imported commodities instead of domestically produced ones, despite high import prices, either because the domestic supply is insufficient or because the quality of internally manufactured goods is very low. Currently, Serbia and Montenegro records the highest import-export ratio among all former socialist countries: 3.04 for the period January - April 2004 (3.2 in case of Serbia alone). The export potential is very limited because of low competitiveness and productivity, while the capacity to reduce in the near future the CA deficit and the accumulated debt is rather modest (the debt - export ratio is 2.5 times higher than the average for transitional economies). In addition, Serbia and Montenegro records the lowest investment rate (13.5% of GDP) among the same group of countries (the average is 23.75%). Low investment in the economy implies a modest growth rate of the GDP in the future and consequently insufficient national income. As a result, paying back the debt will become more problematic in the future, while the sustainability of CA and Trade Balance a serious issue of concern.