An analysis of the factors affecting Iran’s current account balance: A comparative study

The determinants of the current account balance are among the most important issues in open economies. Identifying the determinants of this balance in the short and long runs is of importance for policy makers. The function of the current account balance involves important information about an economy’s performance. It also provides valuable macroeconomic policy recommendations. There are several theoretical models existing in the literature to explain the behavior of the current account balance. Each of them makes different predictions about the elements determining the balance as well as the sign and magnitude of the relationships between the current account fluctuation and its determinants. First, its significance stems from the fact that the current account balance, reflecting the saving-investment ratio, is closely related to the status of the fiscal balance and private savings which are the key factors of economic growth. Second, a country’s balance on the current account is the difference between its exports and imports, reflecting the totality of domestic residents’ transactions with foreigners in markets of goods and services. Third, since the current account balance determines the evolution of a country’s stock of net claims on the rest of the world over time, it reflects the intertemporal decisions of (domestic and foreign) residents. Consequently, policymakers try to explain current account balance movements, assess their sustainable levels and induce changes to the balance through proper measures.

In the present paper, we examine the determinants of the current account balance in Iran based on a cointegration approach and a vector error correction model using seasonal data for 1981-2016. It is also estimated for the selected Asian countries. The initial aim of the empirical research is to identify the main (short- and long-term) determinants of the current account deficits. Following previous theoretical and empirical studies, we estimate a model. The objective of this paper is to examine both the long-run and short-run impacts of the initial stock of net foreign assets, degree of openness to international trade, real exchange rate and relative income on the current accounts for eight selected emerging Asian economies since the 1980s. Four sample economies are Iran, China, India and Korea. Based on the preliminary analysis of the data presented in the last section, all the variables in this study are non-stationary and follow a process. As a general rule, non-stationary time series should not be used in regression models in order to avoid the problem of spurious regression. However, Engle and Granger (1987) pointed out that a linear combination of two or more non-stationary series may be stationary. If such a stationary linear combination does exist, the non-stationary time series are said to be co-integrated, and the stationary linear combination can be interpreted as a long-run equilibrium relationship among the variables.Given the above considerations, we used the co-integration test proposed by Johansen and Juselius (1990), which is a vector-based autoregressive approach, to examine the underlying co-integrating relationships among the variables specified. Given the non-stationary nature of the data used in this study, this paper adopts a co-integrated VAR approach to analyze current account balances and a set of macroeconomics determinants. Johansen and Juselius’ (ibid) co-integration test is first applied to detect the co-integration between current account balances and potential explanatory variables within a VAR framework. In the presence of co-integration, the long-run impacts of all the explanatory variables of current accounts are analyzed based on the estimated co-integrating parameters, while the short-run impacts of all the explanatory variables of the current account are investigated according to the estimation of the vector error correction model (VECM). Compared with a single-equation residual-based approach, Johansen and Juselius’s test is superior in two main aspects. First, all the variables in the VAR system are assumed to be endogenous in the Johansen and Juselius’s test, even if some of them do not serve as dependent variables. As a result, it avoids the problem of normalizing the co-integrating vector on one of the variables or of imposing a unique co-integrating vector, as in the single-equation residual-based test (for example, the 2-step co-integration test by Engle-Granger, 1987). Second, Johansen and Juselius’s approach can address the multi-co-integration problem when there are more than two variables involved in the test, whereas a single-equation residual-based test is only able to find one co-integrating relationship despite the number of variables involved in the test. This second advantage of Johansen and Juselius’s test is especially important to this study given that there are five variables involved in the analysis of current account behavior. The power of Johansen and Juselius’ test is greater than that of the EG test. For all these reasons, this study applies Johansen and Juselius’ test to explore the co-integrating relationship(s) between the current account balance and the explanatory variables.

The results indicate a long-term equilibrium relationship between the current account balance and such determinants as net foreign asset variables, the degree of openness of the economy, and internal production. In the short run, in addition to the mentioned variables, the effective real exchange rate has a weak effect on the current account balance of the sample countries.

Since several studies have highlighted the part played by large current account deficits in the run-up to financial crisis episodes, a considerable body of research has been done on current account determinants recently. Although the selected Asian countries have been facing turbulent current account dynamics over the past three decades, they have not been the subject of enough empirical studies. In this respect, the current paper seeks to fill in this gap in the empirical literature by assessing a wide range of (short- and long-term) determinants of the current account balance as suggested by the (theoretical and empirical) literature. The empirical results are in ways consistent with previous theoretical and empirical studies.