Today’s thread of intro class in contemporary #econissues is on the Current Account surplus. This being Twitter, I can’t get into all the nuances but the plan is to teach me how international trade accounting / balance of payment works.

As always, please feel free to tell me if it is being too simplistic or there is a flaw in the logic or if I am assuming causality. Ignore "export of capital" issue for now.

There are two components of the balance of payments: current account and capital account. Think of current account as income statement and capital account as a balance sheet. Whatever happens in the income statement, its result is reflected in the balance sheet

E.g. a net profit of Rs.100 in income statement means an increase in retained earnings by Rs. 100. There are only two rules for our purposes

Rule one:
Sum of current account and change in capital account should always be zero

Current account + Change in Capital Account = 0

That is an accounting identity. E.g. if exports are more than imports by $100, this is a current account surplus of $100. It will be reflected as an increase in FX reserves or export of capital by $100.

Current A/c + Change in Capital A/c = 0
$100 + (-$100) = 0

Its hard to get the concept of export of capital, agar zindagi rahi, I will explore it. Bengali wasn’t wrong in the first part of tweet. https://twitter.com/kaiserbengali/status/1197329175570464768?s=20 Latter part was frivolous and probably derived from listening to Asad Umar and his economic hitmen theories.

Rule two:
The current account surplus in one country means current account deficit somewhere else.

If I export more to you than I import from you, it implies you import more from me than you export to me. Thus, every country in the world cannot run a current account surplus.

Some countries have to run a deficit to balance the surplus countries. Current account of the globe should balance out to zero.

For our sake, the current account comprises of
1. Import of goods/services (I)
2. Export of goods/services (X)
3. Remittances/Grant/ transfers (R)
4. Dividend and interest (D)

Current Account (CA) = I + X + R + D

I+X, called trade account, is the largest component of CA

If exports more than imports, trade account surplus. .If vice versa, trade account deficit.

CA = Trade Account + R + D

Debt and investments whether from IMF, CPEC or foreign investor are reflected in the capital account ie Equity / Debt is reflected in the Balance Sheet.

Interest or dividend paid/received appears in income statement (IS). Some said investment in T-bill caused the CA surplus. But does debt flow through the IS? No, right! So investment in T-bill is reflected in the capital account and has nothing to do with the CA surplus.

Why is remittance or grant reflected in the current account? Because remittance or grants are one-way flow. They are not paid back. It's like an income, and as such, reflected in IS i.e., in CA. Now that we have the basics covered, let’s look at the October Current Account figure

The first is from the SBP website. I have just summarized it (middle picture) for ease of understanding. I have also attached Arif Habib table where you can see the evolution of current account balance over the years.

When Pakistan is running a current account surplus, there should be a country or countries that together are running a current account deficit against Pakistan for the equivalent amount. Let’s say Pakistan imposed tariffs on Al Marai milk imports from Saudi

How will tariffs reduce imports? By making milk expensive. Assume Pak imports at $1/litre. Pak consumer has Rs.1200 to spend on milk per month. At Rs120 = $1, she buys 10L of milk. Pak imports $10 of milk running a deficit of $10 to satisfy her demand.

Now Pak imposes a 25% tariff on imported milk. Milk now becomes $1.25/L. She is still spending Rs.1200 but now it only gets her 8L. The current account deficit with Saudi is reduced to $8. Her Rs.960 goes for milk with balance Rs.240 into government coffers as tariff revenue.

Next government devalues currency from Rs.120/$ to Rs.160/$. Consumption of milk goes down to 6 litres. The CA deficit with Saudi reduces to $6.

Her cost per liter has gone up from Rs.120 to Rs.200. This Rs.80 increase is to be deemed as a consumption tax for the consumer.

It is hard to predict how consumers will behave. She may also decide that imported milk is too expensive and move to low-quality dairy liquid i.e. Olpers thus reducing the deficit to zero.

We can't guarantee causality i.e., how will consumer behave when such taxes imposed.

Thus tariff and devaluation are a form of consumption tax. Our CA surplus has been achieved by import compression. Import compression works by reducing consumption capacity of the population.

Import compression by devaluation and import tariffs has been the policy followed by China and Asian tigers. You can argue we were living beyond our means importing cheese and compression is a good policy. Or its bad as we were importing chemicals and medicines.

But to know this you need to know what we were importing. This is a brilliant paper by Tabadlab telling you what we import and why. https://www.tabadlab.com/publications/first-response/pakistans-import-bill/

It should have been clear that tariff is a targeted consumption tax where you can decide which commodity you want to impose a tax on. Devaluation as a consumption tax is a blunt tool that targets every imported commodity.

In case you are interested, thread on how SBP policy of increasing the discount rate is also a blunt tool https://twitter.com/2paisay/status/1199794529093783552?s=20

Blunt instruments target everyone rich, poor, consumers, businesses, government based on their composition.

We did not discuss sales tax here which would be another layer of tax over the above-mentioned consumption taxes. If some one tells you that Pakistanis don't pay taxes, just smirk.