The recently published study paper by State Bank of Pakistan (SBP); “Price and income Elasticity of Imports” gives some intriguing insight into the country’s Balance of Payment (BoP) accounts and its relation to growth. The relevance of the study cannot be ignored in the current economic context when country is experiencing large current account deficits monthly. The study highlights that many developing countries rely extensively on running external deficits in order to spur medium to long term growth.

Import price elasticity
The report points out that these large deficits can sometimes have a hard landing in the shape of BoP crisis, which can make a country, go bankrupt. Thus BoP has become an increasingly important indicator over the period as a measure of judging a country’s long term growth prospects. In Pakistan, major components driving the BoP deficit are its rising imports relative to exports. Hence the moot point of the study is what drives the demand for imports in Pakistan and as to what income level affects the demand for import.

Depreciating your way out of trade deficits…
So, what interests us is the policy implication suggested in the study conducted. The study lays out its recommendations on the findings of Heien (1968). It states that if the import price elasticity relative to income falls between -0.5 and-0.1, then exchange rate and import tariff polices can be equipped to tackle the problem of widening trade deficits. In Pakistan’s case, this price elasticity fall under the given range, such that the long-run price elasticity of the country comes out to be -0.53.The basic understanding behind this is rather simple: for every 1% increase in price of imports, the demand for imports shrinks by 0.53%. Hence in order to curtail this rise in imports, policy makers should focus on increasing the cost of imports, providing a simple suggestion