Causal relationship between current account and financial account: the case of Tunisia

ABSTRACT

The Tunisian economy during the last thirty years suffered from a chronic current account deficit. The present paper investigates the long and short-run dynamics between the surplus of the aggregated and disaggregated financial account and the persistent pattern of current account deficit in Tunisia over the period 1977–2009. Based on bounds testing cointegration approach using an autoregressive distributed lag (ARDL), we found evidence supportive of long-run cointegration relationships between the current account and the financial account for both aggregated and disaggregated levels. The results also highlight that there is evidence of unidirectional causality from portfolio investment to the current account over the long-run. These findings suggest that the current account should be used by the Tunisian government as a control variable for capital flows and could be considered as valuable information for the liberalization of the financial account in Tunisia.

KEYWORDS:

• Current account
• financial account
• financial account components
• causality
• ARDL model
• developing country

JEL CLASSIFICATION:

• C32
• F21
• F32
• F34
• F41

Acknowledgements

The authors would like to thank the editor and two anonymous referees for their valuable comments and suggestions.

Disclosure statement

No potential conflict of interest was reported by the author(s).

ORCID

Lotfi Taleb http://orcid.org/0000-0001-5544-6518

Notes

1 More precisely, the factors of the depth and sophistication of the financial system have a positive effect on the current account in developing countries, while the effect is not significant for developed countries.

2 The general Balance of Payments in 1986 reached its peak recording a deficit of 153 million Dinars, while it has often been positive between 1970 and 1982.

3 The economic and financial situation in Tunisia has been thus significantly deteriorated in 1981, and the Tunisian economy has entered the most difficult phase of its evolution with deep macroeconomic difficulties. The growth rate of GDP at market prices was only of the order of 1.2% in 1986 while it was 16% on average between 1971 and 1985. In real terms, the rate was even negative (−2%). Inflation has averaged 9.2% between 1980 and 1986 and reached 13% in 1985. In 1986, the unemployment rate has exceeded 16% of the active population. At the same time, imbalances in domestic and external balances have increased significantly. The current account deficit has more than doubled relative to GDP between 1980 and 1984, reaching a ratio of 10.9%. In recent years, Tunisia is facing new challenges, the Tunisian revolution, political turmoil, and the democratic transition experience that will reshape the socioeconomic reality in Tunisia.

4 It should be noted that there exist various methods to test the long run relationship between a set of variables in particular, the residual based test [Engle and Granger (1987)], the system based test [Johansen (1988)] and the error correction based test.

5 The demerit of this method is that it is not applicable if any of the variables are integrated of order two I (2) [Pesaran et al. (2001)].

6 The twin deficit theory, which supports that a worsening budget deficit stimulates an increase in current account deficit, is widely studied to explain in order to explain the sources of the current account imbalances [Rosensweig and Tallman (1993), Vamvoukas (1999), Piersanti (2000), Leachman and Francis (2002), Baharumshah and Lau (2007), Hakro (2009)].

7 The CA is affected in this case by the nominal exchange rate policy.

8 According to this point of view, the current account equals the difference between domestic savings and investment. In this case, a situation of a current account deficit (surplus) means that domestic saving is smaller (higher) than domestic investment and the country net borrows from the rest of the world.

9 According to this theory, any changes in the FA, are mainly caused by optimization strategies of investors with regard to balancing risk and return.

10 Every international transaction requires two offsetting entries to the balance of payments: One corresponding to the CA and the other on the FA.

11 Note that the reserves are beyond the scope of this study.

12 The Equation (2) is based on the balance of payments identity in the fifth edition of the IMF’s Balance of Payments Manual. This identity needs that a CA transaction can be offset by a FA transaction, via any of the components.

13 It is important to point out that all these three components might move independently or move in the same or opposite direction at the same time, given that there might be a substitution or complementary effects among the FDI, PI, and DEBT.

14 Note that financial account decomposition is beneficial and necessary for finer policy making for two reasons. First, it allows us to specify in more detail the component that finances or worsens the current account deficit. Second, it is especially informative of inter-component additive and canceling out effects.

15 Since 1987, the Tunisian economy has been reshaped based on the Structural Adjustment Plan recommended by the World Bank and the International Monetary Fund. This made Tunisia shift towards a market-oriented economy with more comfortable access to the international borrower to lower interest rates. Reforms concern internal and external policies and infrastructure improvement. Furthermore, Tunisia is the first in North Africa to sign in 1990 the General Agreement on Trade and Tariffs (GATT) and joined the World Trade Organization (WTO) in 1995.

16 The Pesaran et al. (2001) approach is based on testing the existence of a relationship between variables in levels which is applicable irrespective of whether the underlying regressors are purely I(0), purely I(1) or mutually cointegrated. The statistic underlying the procedure of Pesaran et al. (2001) is the familiar Wald or F-statistic in a generalized Dicky–Fuller type regression used to test the significance of lagged levels of the variables under consideration in a conditional unrestricted equilibrium correction model (ECM). The approach of Pesaran et al. (2001) suppose also that the asymptotic distributions of statistics used are non-standard under the null hypothesis that there exists no level relationship, irrespective of whether the regressors are I(0) or I(1). The major advantage of the ARDL approach lies in its identification of the cointegrating vectors where there are multiple cointegrating vectors.

17 Pesaran et al. (2001) give us the critical values of the F statistics for different number of variables (K), and if the ARDL model contains an intercept (or trend). Two sets of critical values are proposed. The first set,assuming that all the variables are I(0) (i.e. lower critical bound which assumes that all the variables are I(0), which mean that there is no cointegration) and another (the second) assuming that all the variables in the ARDL model are I(1) (i.e. upper critical bound which assumes all the variables are I(1), which that mean, that there is cointegration).

18 In particular, we can use the following critirion, Akaike Information Criterion (AIC), Schwarz Bayesian Criterion (SBC) or Hannan-Quinn Criterion (HQC).

19 Although ARDL cointegration technique does not require pre-testing for unit roots, to avoid ARDL model, crash in the presence of integrated stochastic trend of I(2), we are of the view the unit root test should be carried out to know the number of unit roots in the series under consideration. And also, in order to ensure that none of the variables is I(2) or beyond as long as the ARDL aproach will crash in the presence of integrated stochastic trend of I(2).

20 Given the small sample size, considering two breaks in the analysis is sufficient to examine the trending behavior of the series under study and to capture structural changes in the data.

21 Within this context, all variables are considered as long-run, forcing variables for both aggregated and disaggregated levels.

22 This is in accordance with the results of several prior research [Yan (2007), Yan (2005)] and which argue that FA thrusts the CA into an imbalance in most developing countries and that, the aggregated financial account might enhance or weaken the causal relationship between CA and FA due to the canceling-out or adding-up effect.

23 Blanchard and Giavazzi (2002) showed that the cost of borrowing is expected to decrease with increasing financial integration. Even more, poor but developing countries with a lower level of capital, higher marginal productivity and high growth prospects are expected to run current account deficits by increasing their external borrowing to finance domestic investment.

24 Ajisafe, Nassar, Fatokun, Soile, and Gidado (2006) in Nigeria find a similar result over the period 1970–2003.