Academic Research International   Volume 1. Issue 3. November 2011         AN EMPIRICAL STUDY TO FIND THE RELATIONSHIP BETWEEN TRADE DEFICIT AND BUDGET DEFICIT IN PAKISTAN Abdur Rauf PhD Scholar, Department of Economics, Gomal University, DI Khan, PAKISTAN abdur_rauf60@yahoo.com Dr Abdul Qayyum Khan Assistant Professor, COMSATS Institute of Information Technology, Wah Cantt, PAKISTAN qayyum_72@yahoo.com ABSTRACT In this paper an attempt has been made to investigate the relationship between trade deficit and budget deficit in case of Pakistan. Annual data has been used for the period from 1980 to 2009. Also causality between the two has been checked via Granger Causality test to find that which variable is responsible for causing the other. While for simple regression OLS technique is used in the study. The result of the study showed that in case of Pakistan the budget deficit is mainly caused by trade deficit and causality run from trade deficit to budget deficit. Key words: Budget deficit, Trade deficit, Pakistan INTRODUCTION Both budget deficit and trade deficit are known as the twin deficit, which is a concept from macroeconomics and this discuss the relationship between government budget balance and current account balance. Both had very close relationship and it says that reduction in budget deficit is a necessary and sufficient condition for improving the performance of current account. Twin deficit had very important implication for economy because if there is consistency in budget to remain in deficit it will lead to borrowing both internally and externally. And also it impose burden on future generation. The previous work shows four alternative hypotheses which say that 1- budget deficit cause trade deficit, 2- trade deficit cause budget deficit, 3- both are bidirectional and 4- there is found no causality between the two. Common belief is that budget deficit in an economy is signal to trade deficit but also trade deficit may cause budget deficit. We know that if there is budget deficit in a country that mean that the expenditures are greater than the revenues and greater expenditures mean that the country imports are in high proportion than what she exports. So it is a phenomenon of trade deficit. To minimize the trade deficit country needs to expand its exports but if the export of a country belongs to the weaker sector of the economy then revenue collection will decline and as we said that the expenditures of the government are already increased so the result will be budget deficit thus here the trade deficit caused budget deficit. Now if both shows no relation then the reduction in budget deficit will not solve the problem and this will divert the attention from more urgently needed policy options which address productivity competitiveness in foreign market and export promotion programs. Almost all the developing countries face a phenomenon of twin deficit which mean that there is both trade deficit and budget deficit in the economy. Pakistan being a developing country also faced the same problem persistently throughout its history.