Balance of Payments Disequilibrium :
- Balance of Payment disequilibrium refers to an imbalance in balance of payment due to a surplus (favourable ) or a deficit (unfavourable or adverse) balance of payment.
- A country’s balance of payments is said to be in disequilibrium when its autonomous receipts (credits) are not equal to it autonomous payments (debit).
- If autonomous receipt (credit) is greater than autonomous payments (debits) the balance of payment is in surplus. A surplus in the balance of payments generally does not pose much of a problem.
- If autonomous receipts (credit) are less than the autonomous payment is in deficit.
- A deficit in BoP often creates a difficult problem for the economy. Therefore it is important to understand the causes of deficit BoP.
Causes of Adverse Balance of Payment or Deficit in BoP:
Adverse balance of payments of a country may be due to various reasons. The main causes of adverse balance of payments are as follows :
1. Fall in foreign Demand
2. Inflationary Pressures in the Economy
3. Developmental Expenditures
4. Population Pressure
5. Demonstration Effect
6. Appreciation in the Exchange Rate
7. Decrease in Supply
8. Increase in Cost Structure of Export Industries
1. Fall in Foreign Demand:
- Deficit in BoP may arise due to the shifting of foreign demand from country’s goods to the products of other countries.
- This may be due to change in taste and fashions of foreign consumers or because of lower price of other countries goods.
- A fall in foreign demand leads to decrease in exports making BoP unfavourable.
2. Inflationary pressure in the Economy:
- Domestic inflation also cause BoP imbalance.
- A high rate of inflation causes – rise in price which encourage import by making import cheaper.
- High rate of inflation may also reduce export.
- Due to this increase in import and decrease in export there arise a deficit in BoP.
3. Developmental Expenditure or Structural deficit:
- In developing countries the balance of payment generally becomes unfavourable due to their developmental efforts.
- These countries import foreign machinery skilled labours, raw material and technical countries.
- This pushes up their import bills.
- This leads to a deficit in balance of payment.
- This is also known as structural deficit.
4. Population Pressure:
- This problem arise in underdeveloped countries with large population.
- Due to large population, their arise increased demand for all types of goods.
- This result in fall in export and some time increase in import.
- This result in fall in export and some time increase in import.
- This cause an adverse effect on the balance of payments.
5. Demonstration Effect:
- People of underdeveloped countries try to imitate the consumption patterns for luxuries like cars, air conditioner etc., of the people of developed countries.
- This led to a large increase in the import of consumer durable goods leading to deficit in BoP.
6. Appreciation in the Exchange rate:
- Adverse balance of payments also caused by appreciation in exchange rate.
- Appreciation of a country’s currency in foreign market increases the external value of currency.
- This makes import cheaper and export expensive.
- This resulting in increase in import and fall in export leading to deficit in balance of payment.
7. Decrease in Supply:
- A fall in production in any sector or all sector affect the supply.
- Agricultural production may fall due to natural factors like draught, flood or failure of crops.
- Industrial production may cause due to labour strike, shortage of raw material or shortage of power supply etc.
- Which result in fall in export and a rise in import to overcome the scarcity of goods in domestic market.
- This cause a deficit in balance of payment.
8. Increase in cost Structure of Export Industry:
- Increase in cost structure of export industry will reduce the volume of export in world market.
- Cost structure may increase due to higher wages, higher price of raw material, high rate of inflation etc.
- Fall in export directly affect the balance of payment.
Measures to Correct Disequilibrium in Balance of Payment:
A number of steps can be taken to tackle the problem of deficits in the balance of payments. The main methods of correcting the adverse balance of payments are:
1. Depreciation
2. Devaluation
3. Import Control
4. Export Promotion
5. Encouraging Production of Import Substitutes
6. Capital Import
1. Depreciation:
- Under the flexible exchange rate system, a deficit in BoP can be reduced by depreciation of currency.
- Depreciation of currency means a fall in the price of domestic currency or a rise in the price of foreign currency.
- Due to depreciation of domestic currency the traded imported goods become costlier and import become expensive which result in a fall in import.
- On the other hand, traded exported good become cheaper and hence export will stimulated. This way BoP deficit will be reduced.
- Under the fixed exchange rate system, the government pursues specific economic policy to adjust the balance of payments.
- Even under flexible exchange rate system, the government does not rely entirely on automatic adjustment.
- The emphasis, therefore, is on achieving external balance through appropriate exchange rate policy.
2. Devaluation:
- A country can devaluate its domestic currency to wipe out the deficit in balance of payment.
- Devaluation of currency makes import expensive to domestic consumers and export cheaper in foreign countries.
- This will lead to fall in import and rise in export, thereby reduce the balance of payment.
3. Import Control :
- To reduce the deficit in balance of payment, government can adopt a wide variety of import control measures such as quotas and tariffs.
- Import quota is a quantitative restriction in the volume of import.
- In this measure government fix or limit the quantity of imported goods to control import.
- Government may also increase the import duties or tariffs which result in the rise in prices of imported goods and reduce imports.
- Hence deficit in balance of payment is reduced.
4. Export Promotion:
An important method of reducing deficit in BoP is to stimulate export which increase the acquired foreign exchange and reduce deficit in balance of payment.
Government may adopt several measures to promote export :
- By reducing export duties,
- By providing subsidies and cash assistance to exporters.
- By providing various facilities – like quality control, arranging exhibition of exportable goods in foreign countries.
- Providing tax benefits, finance, cheap raw material to export oriented industries.
- Encouraging tourism by attracting foreign tourists to earn foreign exchange.
5. Encouraging Production of Import Substitutes:
- To reduce deficit in BoP, import should be reduced and export stimulate.
- Government may encourage the production of import substitutes which can replace the imported goods in short run and reduce the import.
- If the industries producing import substitute develop ultimately, they may turn out to be export earners as well.
6. Capital import:
- The imbalance in the trade balance can be corrected by borrowing capital from individuals, and government of other countries or international financial institution like IMF ( International Monetary fund) etc.
- Countries can use SDR (Special Drawing Rights) facility to meet the deficit in the balance of payments.
- SDR or Special Drawing Rights is not a currency it is an international reserve asset created by IMF to supplement the member countries.
- They are made up of basket of major foreign currencies like – US dollars, Pounds, Euro, Yen etc.
- SDR are used as a supplementary foreign exchange reserve for IMF member countries for balance of payments settlements.
- Countries may attract private capital from abroad by providing tax concession to foreign investors.
Question: What is SDR ?
Answer:
SDR stands for Special Drawing Rights
- SDR is an international reserve asset, created by the IMF in 1969 to supplement its member countries’ official reserves.
- It is made up of a basket of major foreign currencies like – US dollar, Pound Sterling, Euro Yen etc.
- SDR is used as a supplementary foreign exchange reserve for IMF member countries for balance of payments settlements.
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