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Adjustment of Balance of Payments’ Disequilibrium

Presented by Group no 4( roll no 30 to 40)

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Equilibrium in Balance of Payment of Nations

When demand for and supply of foreign currency in a nation in a given period are equal – it is viewed as equilibrium position in BOP.

But in case of most of nations, it is not so i.e. they either enjoy a surplus BOP or deficit. It represents disequilibrium in BOP.

The systematic record of all economic transactions between residents of a

country and rest of world in a given period is called the Balance of

Payment.

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A): Unfavorable balance of payment.

Balance of payment is unfavorable when the payment(import) of

the country are more than its receipts(export).

B): Favorable balance of payment.

Balance of payment is favorable when the receipts (export) of the

country are more than its payment(import).

Two forms of disequilibrium

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Disequilibrium in BOP are caused by :

• Economic Factors.• Natural factors• population explosion• Foreign capital investment• Demonstration effect• Political Factor.• social Factor.

CAUSES FOR DISEQUILIBRIUM

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* Economic Factors may cause 1) Development Disequilibrium 2) Cyclical Disequilibrium 3) Secular disequilibrium and 4) Structural Disequilibrium

1. Development Disequilibrium

Developing countries mostly take up activities like establishment of industries, infrastructure etc. which require greater imports of capital goods, machinery etc. In addition it also shoots up imports of consumer goods on account of increase in per capita income and aggregate demands. Thus increased developmental activities result in greater outflow of foreign currency leading to deficit in BOP.

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2. Cyclical Disequilibrium

It occurs due to business cycles. The cyclical changes cause

disequilibrium in the balance of payment. When prices rise

during prosperity and fall during depression, the country which

has highly elastic demand or imports faces a fall in the value of

imports and if it counties its exports it will have a surplus in the

BOP and vice versa.

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3. Secular Disequilibrium

It mostly happens in developed countries where disposable income

of people are very high. It raises in turn the cost of production and

price of goods and services. Consequently, developed countries

prefer to outsource goods and services from other countries where

quality of goods is high and cost . of production is low. It may

lead to secular disequilibrium in BOP of nation.

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4. Structural Disequilibrium

Sometimes notable shift comes in nature of economy of countries e.g. from agricultural to manufacturing or services. These may call for structural changes in developing alternative items, sources of supply, changes in transport channels and also costs.These structural changes may enhance imports of capital goods and consumer goods resulting in deficits in BOP.

India’s BOP Disequilibrium due to Structural Changes Between 1999-2000 & 2000-2001, structural changes in India’s economy increased POL imports from $ 5.64 b. to $ 9.77 b. ; electronic goods from $ 1.47 b. to $ 2.05 b. etc.

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Natural factors

sometimes due to natural and other factors, industrial and agricultural

production in the country falls. Consequently exports of fall and if import

are not cut off , BOP becomes adverse.

Population Explosion

In the underdeveloped country aggregate consumption demand increases

due to rapid increase in population. As a result of this export surplus falls

down

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Foreign capital investment flow.

When a country induced by profit motive makes large capital investment in

the foreign countries then then this capital out flow has an adverse affect on

bop capital expenditure.

Demonstration effect.

Nurkse opined that people of under developed countries try to imitate the

consumption pattern of the people of the developed country. So their

import increases very much and cause disequilibrium in BOP

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* Political Factors Political uncertainties, instability, internal disturbances, external wars etc. create threatening situation for local industry and investments. In such cases domestic production declines leading to increase in imports and outflow of capital It results in deficit in BOP as it happened in Sri Lanka, Pakistan etc.

Social Factors Changes in culture, taste, preference, fashion etc. bring about changes in nature of import of consumer items first, followed by capital goods leading to deficit in BOP.

Correction of BoP disequilibrium

Automatic correction

Deliberate measures

Monetary measures

Trade measures Miscellaneous measures

Export promotion

Import control

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Correction of BOP Disequilibrium

When BOP becomes surplus, nations enjoy the same as it

offers a number of desirable situation like increased

purchasing power and influence in global market.

In cases of disequilibrium due to deficit, countries adopt

measures to eliminate the same completely, if not possible

at least reduce it.

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Deficit in BOP indicates that demand for foreign exchange is

higher than its supply in the nation. It leads to devaluation of

local currency in relation to the foreign currency. Thereby

imports become costlier and exports cheaper. So imports get

reduced and exports are increased. Thereby outflow of

Foreign exchanges is reduced and income is increased leading

to automatic restoration of equilibrium.

1. Automatic Correction of BOP Disequilibrium

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2. Deliberate Measures Govt. also adopts certain measures to control deficit BOP called ‘Deliberate Measures’ as indicated.

A. Monetary Measures

* Reduction in Money Supply : ( through Interest rate, deflation

Cash reserve ratio, Statutory liquidity ratio , Repo , Marginal standing

facility. etc.)

RBI takes to control credit so that money supply in the country is

reduced which leads to decline in income, purchasing power,

aggregate demand and consumption. Thus imports decline and hence

outflow of foreign currency. In turn exports grow and inflow of

foreign currency to set right BOP disequilibrium.

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Deflation : fall in the home currency through dear money policy resulting in a fall in cost and prices and hence stimulating exports and discouraging import.

Depreciation: Fall in the rate of exchange of one currency in terms

of another. This will make import costlier, because one has to pay more in case of depreciation of currency. So the import become very expensive. But export will become less expensive and that would result in increased export and there by automatic correction.

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* Interest Rate Adjustment :

Inflow of Foreign Exchange in deficit BOP nation falls, so

liquidity falls. So on short term basis ‘Interest rate’ is raised –

leading to investments and loans coming from foreign nations

improving BOP scenario.

* Devaluation

In case of deficit BOP, purchasing power of local currency reduces,

the Govt. deliberately devalues currency. Thus imports become

costlier and exports cheaper. Hence increased exports and reduced

imports balance the disequilibrium of BOP.

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* Exchange Control

Exporters are to surrender the foreign exchange earned to

RBI through authorized dealers and importers are to draw

foreign exchange from authorized dealers.

-- Through suitable policies from time to time, Govt. of

India and RBI control imports to reduce deficit of BOP.

B. Trade Measures

These measures try to restore equilibrium through

increasing exports and/or reducing imports.

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* Export Promotion Measures

Govt. of India endeavor to boost exports by reducing

export duties, providing incentives, encouraging EOUs,

forming EPZs, FTZs etc.

* Import Control Measures

Import control measures include ways and means of

restricting imports through duties, quotas, licences etc.

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C. Miscellaneous Measures

Govt. of India tries to remove BOP disequilibrium by

assortment of means like

a) Attracting Foreign Investments both FDI and FPI

b) Attracting NRI deposits

c) Promoting tourism

d) Negotiating Foreign currency loans etc.

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Thank you