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Disequilibrium in the Balance of Payments

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Disequilibrium in the Balance of Payments
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Page 1: Disequilibrium in the Balance of Payments

Disequilibrium in the Balance of Payments

Page 2: Disequilibrium in the Balance of Payments

Balance of Payment is considered in equilibrium when the demand and the supply of the foreign currency of a country are equal. It is hardly considerable that the balance of payments can be in equilibrium. In some countries the demand for the foreign currency is more than the supply of that. On the other hand in some countries the supply of the foreign currency is more than the demand for that. It should be noted that almost all the countries have either a deficit balance of payments position or surplus balance of payments position.

Page 3: Disequilibrium in the Balance of Payments

Causes of Disequilibrium The causes of disequilibrium can be

divided into three types, economic factors, political factors and sociological factors.

Page 4: Disequilibrium in the Balance of Payments

Economic Factors; Economic factors can be further

divided into four parts; developmental disequilibrium, cyclical disequilibrium, secular disequilibrium and structural disequilibrium.

Page 5: Disequilibrium in the Balance of Payments

Developmental Disequilibrium;

Such kind of disequilibrium exists because of the economic development of the nations. As we know that most of the developing countries takes up the developmental activities like road, railway and the establishment of the new industries. As we know that such kind of activities are capital intensive, they increase the imports of machines and other capital equipments.

On the other hand the result of the developmental expenditure is the increase in the level of income of the citizens of that particular country as well as the increase in the demand of foreign consumer goods. Now we can say that the developmental expenditure results in the increase of the consumer and the capital goods imports and leads to the deficit in the balance of payments.

Page 6: Disequilibrium in the Balance of Payments

Cyclical Disequilibrium Cyclical disequilibrium is concerned with the

fluctuations in imports and exports due to business cycles. The boom in the business activity in one country increases consumption, aggregate demand, and prices more than production. Therefore, the countries experiencing boom conditions import consumer goods immediately to meet the increased aggregate demand. Later it increases the import of capital goods in order to establish new or expand the existing production capacities. Thus, the boom condition increases the imports. In contrast, the depression conditions contribute to the growth in exports as the production is higher than the aggregate demand and consumption. Both the boom and depression conditions result in disequilibrium in balance of payments.

Page 7: Disequilibrium in the Balance of Payments

Secular Disequilibrium;

The balance of payments deficit persists for a longer time period due to secular trends in the economy. As we know that the level of income of the citizens of developed countries are very high, as a result the disposable income was also high, and it will increase the prices of the factors of production as well as that of goods. As a result for a developed country it is better to import goods from other countries where those goods are produced at a lower cost.

Page 8: Disequilibrium in the Balance of Payments

Structural Disequilibrium; Because of the shifting from

agriculture sector to service sector, developments of the alternative sources are considered on structural changes. These structural changes increase the value of imports for capital and consumer goods. And the result is balance of payments deficit.

Page 9: Disequilibrium in the Balance of Payments

Political Factors; Some of the factors like, political instability

or political uncertainties, domestic violence or conflicts among the citizens of a particular nation and external war can affect the balance of payments adversely. As a result the domestic production decreases and it also increases the outflow of capital. As a result the imports increases and it leads to deficit in the balance of payments.

Page 10: Disequilibrium in the Balance of Payments

Social Factors; Some of the social factors like

changes in the tastes and the preferences of the consumers, increase in the standard of the living, changes in the existing culture and habits can increase the amount of imports and it leads to the deficit in balance of payments.

Page 11: Disequilibrium in the Balance of Payments

Methods of Correction of Disequilibrium It should be noted that the disequilibrium in balance

of payments exists because of two reasons. The first one is surplus in balance of payments and the second one is deficit in balance of payments. In the first condition when the disequilibrium in balance of payments exists because of the surplus in balance of payments, all the nations will enjoy this, because it is the most desirable position for all the nations. But in the second condition of the deficit in balance of payments all the countries or the nations take some steps to reduce the deficit or if it is possible to eliminate the deficit.

Page 12: Disequilibrium in the Balance of Payments

These steps or the measures can be divided into four parts,

Automatic Corrections Deliberate Measures Trade Measures Miscellaneous Measures

Page 13: Disequilibrium in the Balance of Payments

Automatic Corrections;

As we know that the deficit of balance of payments shows a greater demand of foreign exchange than that of supply. It indicates that the payment for exports is more than the receipts for imports. To correct this situation the possible way is currency devaluation. In this method the external value of the currency has been devaluated. The increased exchange rate makes the imports costlier and on the other hand exports cheaper, so that the country reduces imports and increases exports. This in turns increases foreign exchange reserves and restores equilibrium position.

Page 14: Disequilibrium in the Balance of Payments

Deliberate Measures1; As per the prima fascia, deliberate

measures deals with the correction of balance of payments disequilibrium by means of measures taken deliberately with this end view.

The various deliberate measures can be divided into three parts, (1) Monetary Contraction, (2) Devaluation and, (3) Exchange Control.

Page 15: Disequilibrium in the Balance of Payments

Monetary Contraction The level of aggregate domestic demand, domestic price

level and the demand for imports and exports may be influenced by contraction or expansion of money supply so that balance of payments disequilibrium may be corrected. For instance, assume a situation of balance of payments deficit to correct which a contraction of money supply is required.

Contraction of money supply is likely to reduce the purchasing power and thereby, the aggregate demand. It is also likely to reduce domestic prices. The fall in the domestic aggregate demand and domestic prices is likely to increase exports. Thus, the fall in imports and rise in exports would help correct the disequilibrium.

Page 16: Disequilibrium in the Balance of Payments

Devaluation Devaluation means the reduction of the

official rate at which the currency is exchanged for another currency. A country with fundamental disequilibrium in the balance of payments may devalue its currency in order to stimulate its exports and discourage imports to correct the disequilibrium. Devaluation makes export goods cheaper and imports dearer.

Page 17: Disequilibrium in the Balance of Payments

Exchange Control Exchange control is a popular method employed to

influence the balance of payments position of a country. Under exchange control, the government or central bank assumes complete control over the foreign exchange reserves and earning of the country. The recipients of foreign exchange, like exporters, are required to surrender foreign exchange to the government or central bank in exchange for domestic currency. By virtue of its control over the use of foreign exchange, the government can control imports.

Page 18: Disequilibrium in the Balance of Payments

Trade Measures Trade measures includes, export promotion

as well as reduction of imports Export Promotion, Exports can be

encouraged by reducing the rate of tariffs, or by abolishing exports duties, providing export subsidy, and also through various incentives.

Imports Control, Imports can be controlled by imposing import duties, increasing the rate of tariffs and quotas, licensing and many more steps can control the imports.

Page 19: Disequilibrium in the Balance of Payments

Miscellaneous Measures We have many more measures to

correct the position of disequilibrium in balance of payments, apart from what we have discussed above, like the foreign loans, encouraging foreign investment, etc.

Page 20: Disequilibrium in the Balance of Payments

Thank You


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