Balance of Payments

Adjustment of Balance of Payments Disequilibrium 1Presented by Group no 4( roll no 30 to 40)2Equilibrium in Balance of Payment of NationsWhen 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.3A): 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 disequilibrium4 Disequilibrium in BOP are caused by :

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

CAUSES FOR DISEQUILIBRIUM 5 * 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.62. 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.7 3. Secular DisequilibriumIt 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. 8 4. Structural DisequilibriumSometimes 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. Indias BOP Disequilibrium due to Structural Changes Between 1999-2000 & 2000-2001, structural changes in Indias economy increased POL imports from $ 5.64 b. to $ 9.77 b. ; electronic goods from $ 1.47 b. to $ 2.05 b. etc. 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 ExplosionIn the underdeveloped country aggregate consumption demand increases due to rapid increase in population. As a result of this export surplus falls down9Foreign 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 BOP9/9/2013BoP Disequilibrium1011 * 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 disequilibriumAutomatic correctionDeliberate measuresMonetary measuresTrade measuresMiscellaneous measuresExport promotionImport control1213

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. 14 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 15 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.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.9/9/2013BoP Disequilibrium1617 * 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. * DevaluationIn 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. 18 * 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. 19 * 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.20 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.Thank you9/9/2013BoP Disequilibrium21