Answered: Asian Development Bank (ADB) has warned…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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The Asian Development Bank (ADB) has warned that a BoP crisis is imminent in Pakistan, if its economy grows more than 3.8% annually without fixing economic imbalances. Pakistan will have to fix its exports and reduce dependency on imports to avoid the next balance of payments crisis. “In the current structural and product specialization circumstances, if Pakistan’s economy is to grow faster than 3.8% in the medium-term, external imbalances will occur,” the report warned. The ADB paper noted that since end-2017, the government has implemented a number of economic reforms to address the BOP crisis, including regulatory measures, reduced imports, increased interest rates, and allowed depreciation of the exchange rate to the US dollar by almost 33%. Despite significant currency depreciation, merchandise exports did not pick up significantly and Pakistan’s total debt and liabilities have risen sharply. On average, over the last decade, Pakistan had lost global market share with foreign exchange reserves declining. According to latest quarterly report by SBP, Pakistan’s BoP is showing signs of stabilizing in Q1-FY2021 as the country contained the initial domestic spread of Covid-19 and economic activities resumed from July onwards – helped by a significant expansionary monetary and fiscal policy. Consequently, imports have started to pick up. The significant reduction in global oil prices played a major role in curtailing energy and overall import payments and alleviating some pressures from lower export receipts in first quarter of 2020. Workers’ remittances, on the other hand, proved to be instrumental in generating the first quarterly current account surplus in more than five years, as inflows reached a record high. The resulting improvement in the current account led to increased foreign exchange liquidity in the interbank market and was reflected in a build-up in the country’s foreign exchange reserves and an appreciation in the Pak Rupee. Yet the BoP situation is still very fragile. According to the ADB paper, “Improving Pakistan’s export performance remains the most relevant long-term structural challenge to alleviate the balance-of-payments constraint to sustained economic growth”. Using IS-LM framework explain how come economic growth of 3.8% can cause BoP crises in Pakistan? Using Mundell–Fleming model, comment whether or not monetary policy of “increased interest rates, and allowing depreciation of PAK rupee” for reducing imports and improving competitiveness was a good policy? Also comment what needs to be done to address the BoP imbalance in the long run.

Definition Definition Increase in the amount of goods and services produced by a country in a given period of time compared to an earlier period. Economic growth is generally coupled with a rise in national income or the purchasing power of individuals. It is often measured in terms of the increase in a country's gross domestic product (GDP), or the overall monetary value of all the complete or final services and goods that a country can produce within its domestic boundaries in a specific period.

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