Question 19M.2.HL.TZ0.2b
| Date | May 2019 | Marks available | [Maximum mark: 4] | Reference code | 19M.2.HL.TZ0.2b |
| Level | HL | Paper | 2 | Time zone | TZ0 |
| Command term | Explain | Question number | b | Adapted from | N/A |
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.]
Using an exchange rate diagram, explain how the central bank might depreciate the value of the rupee (paragraph [3]).
[4]
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.
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.
