Determinants of Current Account Deficit in Developing Countries: The Case of Bangladesh

Abstract

Co-integration and Error Correction Model (ECM) are employed to study the behavior of Current Account Deficit (CAD) of Bangladesh and its determinants. The determinants of CAD include budget surplus, domestic saving, domestic income growth, foreign income growth, foreign interest rate, terms of trade, export and real exchange rate. A long-run equilibrium (co-integration) relationship is found between CAD and its determinants, although some variables are non-stationary. Out of eight independent variables only three of them namely, terms of trade, export and foreign interest rate, are found to have significant impact on CAD both in the long and short run. ECM formulation of the CAD model shows that more than 72% discrepancy between actual and long-run value of CAD is corrected in each year. The important implication of the study is that domestic economic policy has little to do with correcting CAD as all significant factors are related to the external economic conditions.