LITERATURE REVIEW:

The research findings of Arnor Sigvatsson (2001) in the current account deficit in an international and historical context suggested that current account deficit is natural phenomena either its Iceland with 9% of GDP or US, but when it gets excessive its a symptom not a disease its self. The sustainable deficit concept has been discussed in detail and certain changes in assumptions have caused different changes in results. A countrys net foreign asset position will continue to deteriorate in future until exports grow considerably faster than imports. There is also view that there is little to fear because public sector is generating a surplus and the deficit is entirely due to private sector. The important thing discussed is about the stability in economic policy to keep market participants confident about the stability of the currency. In this paper the author discussed that there is no sufficient forecasting model exist to forecast turning points. In case of Australia and New Zealand, which experience deficit for many years. In different periods the reason of deficit has been attributed to terms trade, fiscal deficit and strong exchange rate has dampened export growth. In this paper referring to International Context for current account deficits calls for several concerns mainly potential GDP growth. A current account deficit may be considered unsustainable if it cannot be sustained without a sudden shock. It can be concluded that this position actually poses more risk for the economy as a whole. Another important issue that has come a cross that the foreign debt shouldnt be the major concern because it can be amortized with the sale of assets but the underlying issue is that all the assets of th country doesnt lie in same hands and which can ultimately lead to deficit special net capital inflow part, as happened in case of Iceland. According to the study of Ahmet Mancellari and Selami Xhepa (2003),refered in his paper Current account sustainability in case of Albania the current account status is chronic in high levels. It is apparent by the study done that the improvement of the Current Account balance requires above all, the improvement of trade balance and which is contingent on growing exports. Export growth is possible through competitiveness. Whereas real exchange rate appreciation on exports is weak in the Albanian case. In first part of paper

author emphasized that how the current account deficit can be identified as it is difference between the saving and investment for the overall economy, which can help in measuring the strength of developing countries economies. The negative difference as author indicated between saving and investment can have adverse effects on the external economy. Author had applied a synthetic approach, the international debt servicing is identified a key indicator of sustainability of current account deficit, a range of criteria stemming from the above theoretical criterion can be used for practical purposes, such as the foreign debt to GDP ratio; external sector crisis incidence; investment growth rates rapport compared to the pace of saving growth rates; the current Account deficit structure; structure of capital inflows; gross internal reserves dynamics, compared to debt stock; financial system status and especially the banking system status and the predictability of economic policies and developments. The above mentioned different measures are used by author in second part. The Author focused on real exchange rate, macroeconomic variable. And it adapted according to relative inflation indicator following equations has been employed: RER = ErPf P Where RER represents the real exchange rate, Er represents the nominal exchange rate, p f represents the price index in the foreign country and P represents the price index in the given country. The author concluded is paper with main recommendation that current account sustainability is dependent on the restructuring of economic policies of the country.

As Nouriel Roubini and Paul Wachtel (1997), mentioned in their article Current Account Sustainability in transition Economies. Author as emphasized in this article that current account is a key indicator of performance for economies in transition. It reflects strength of

economy by telling how many a resources are coming in where as a warning of imbalance between saving and domestic investment and foreign debt. It is worth mentioning that the countrys current account deficit and economic growth is also realted, if current account deficit grows with greater rate than economic growth than it is alarming situation however if current account deficit is big but economic growth rate is also greater than current account deficits are sustainable. Author has also indicate issue that in transitional economies banking crises are common, which are due to bad lending practices of the banks. If these banks are lending from abroad than the problem became severe and larger in its impact. So banking system fragility is also important thing to consider in developing economies. Ten different countries situation has been taken in account and their banking practices. In all these countries with transition economies, banking crises are strong indication of fundamental problems and loss of international confidence in these economies and thus lead to devastating condition of current account of that country. Author pointed out that the judgment about the current account stability ids dependent on the understanding of real exchange rates, which are hard to identify in developing economies an further macroeconomic conditions are rapidly changing in these countries which is hard to interpret. Research findings of Gian Maria Milesi-Ferretti And Assaf Razin (1995) in Sustainability of persistent Current Account Deficits have showed that the case of un-sustainability exists if the country continues to entail current policy and private sector needed drastic policy change. The drastic policy change usually is triggered by the domestic or external shock, which causes international confidence to shift. Author also discussed the concept of intertemporal budget constraint, which accommodates variety of future behavioral patterns. This concept than explained by following equation:

Where the lower case variables shows the ratio of respective variables to GDP. This above equation manly emphasis that the changes in the ratio of foreign assets to GDP are due to trade imbalances. For more efficient allocation of investment and smoothing of consumption intertemporal borrowing and lending is natural vehicle to achieve faster capital accumulation. Persistent current account deficits are red light if export sector is considerably small and debt servicing of country is large, saving are less and banks dominate the financial sector.

According to the study of Maurice Obstfeld and Kenneth Rogoff (2000) in The Unsustainable U.S Current Account Position Revisited , and the model they employed of two country extension to small country endowment, shows the home consumption index depends on Home and Foreign tradable, as well as domestic non tradable. They used following equation for that change in relative tradable prices indexes:

Equation illustrates, the larger the share of non traded goods (1 ) in consumption, the bigger the effect of changes in the relative international price of non traded goods. The large size of U.S in the World econmy implies that when the U.S current account shrinks, the US Citizen are more inclined to non traded goods, which than play its part to reserve in the rest of world. However if US were a small country than dollar depreciation would have greater impact. The terms of trade also played important role in levering up the required depreciation of the dollar.

Zafar ul-Hassan Almas (2009) pointed out in Pakistans Current Account Deficit: Tackling the Sustainability Issue, to study the long term view of economic variables of the current account it is necessary to see the

structural features of economy, such as levels of economy profiles and the structures of consumption and production. With regard to Pakistan current account deficit which is 5% of GDP and declined after 9/11 and due to government devaluation of Pakistani rupee, has now reached alarming stage. As author suggested that Pakistans transitional economy has to rely on the current account deficits because it has been an important indicator for its current account growth, but current account sustainability is always a major concern. Author have raised the fact that poor government spending practices its impact is quiet apparent in economy wide fiscal policies. With high injection of FDI in country, this current mode of reckless and directionless inflows of foreign investment will not serve any purpose, be it job creation, technological up-gradation or financing of the current account deficit through non-debt creating inflows. In Pakistan the increasing external debt to GDP ratio is also a major indication of unsustaibility. This implies that a current account balance that leads to increasing external liabilities is an indication of un-sustainability of the deficit. Pakistan has a comparative advantage in information technology services and tourism, and there should be emphasis on obtaining outsourced contracts from the industrialized world. Remittances can be boosted as well by negotiating labor market opportunities in the East Asian economies and the Middle East countries. In this regard, the productivity of Pakistani labor should be enhanced by imparting quality training and apprenticeships. According to author the combination of these actions would narrow the countrys trade imbalance and help restore the sustainability of its current account deficit. Anders Vredin And Anders Warne (1991), published in their Journal Current Account And Macroeconomic Fluctuations, Author referring to previous researches mentioned that current account account component is not counter cyclical that the changing component of current account is not more volatile. In this paper author has focused on non stationary components and the stylized facts are confined to these components. The current account component in this paper is positively correlated to the transitory component of output. In results, it gives the standard deviations of the transitory components of output (uY), savings (Us), etc. We see that the transitory components of both savings and investments are more volatile than the non transitory component of output. Somewhat surprisingly, savings are more volatile than investments The paper, Valuation effects and sustainability of current account imbalances in OECD countries- An empirical assessment accounting for discontinuities and cross-section dependence was published in October 2009 which analyzes the external solvency of a group of twenty OECD countries for the period 1970-2006. The aim of this research was to test for sustainability following the framework defined in Milessi-Ferretti and Razin (1996) and Taylor (2002). The main results of the models are tested using panel stationary tests with structural breaks and cross-section dependence.

Since the beginning of the 1990s, current account (CA) imbalances have been widening considerably in the world economy. The size of the imbalances has raised the key question of their sustainability and the nature of the adjustment process. The two key concepts stated in this paper are as follows: First, the current account is said to be solvent if it is I(0) stationary. Second, the current account is sustainable if the economy is able to satisfy its long-run intertemporal budget constraint without a drastic change in private sector behavior or policy shifts. This is a general concept and does not depend on any particular model. First test for I(0) stationarity of two variables: the current account balance to GDP ratio and the Net foreign assets position to GDP ratio was tested. The current account of a country is treated as a reflection of consumption and investment decisions that span over long-term horizons. More recently, the ratio of net international debt to GDP has provided an alternative method for assessing the sustainability of a countrys current account deficit. Net international debt is the accumulation over time of current account deficits. If an economy runs a current account deficit consistently, net international debt may become so great that foreign investors lose confidence in the economys ability to service its debt or, worse yet, repay the principal. Once this happens, interest rates must rise or the borrowing countrys currency must depreciate to enable the country to continue financing its deficit. In this case, the current account deficit has generated economic forces of its own to change its trajectory, and the current account deficit and the associated debt have become unsustainable. This model follows an intertemporal approach and comprises two elements: an intertemporal budget constraint and a long-run stability condition. N F At = (1+rt)N F At1 + NXt , Where NXt is net exports. Dividing by the level of GDP and imposing the foreign debt sustainability condition that the ratio of NFA to GDP be constant at nf a, we find that the critical net exports to GDP ratio, nxis:10 Nx* = (g rL)nf a* where g is the growth rate of nominal GDP.The critical current account to GDP ratio ca is: ca = g nf a*. In general, the individual country results point to the fact that policy measures or, otherwise, abrupt market readjustments, are still needed to keep a sustainable current account. However, the intertemporal approach formulated at the beginning of the 1980s has emphasized the role of forward-looking expectations in explaining current account patterns. The current account of a country is treated as a reflection of consumption and

investment decisions that span over long-term horizons. According to the paper there is evidence of the current account being an I(0) stationary process once structural breaks and cross-section dependence are allowed for.