A balance of payments (BOP) disequilibrium occurs when there is an imbalance between a country’s international payments and receipts. If a country has a deficit in its BOP, it means that it is importing more goods and services than it is exporting or that it is paying out more money to foreign investors than it is receiving.
Conversely, if a country has a surplus in its BOP, it means that it is exporting more goods and services than it is importing or that it is receiving more money from foreign investors than it is paying out.
The main problem is checking the adverse Balance of payments.
Disequilibrium in the balance of payments (BoP) occurs when a country’s total payments to other countries exceed its total receipts from them over a given period.
This can result in a shortage of foreign exchange reserves, leading to difficulties in financing international trade and making payments on foreign debts.
Methods to Correct Disequilibrium in Balance of Payments
Here are some measures that can be taken to correct a BoP disequilibrium:
1. Monetary Policy (Deflection)
Monetary policy may be devised to correct a deficit in the balance of payments of a country. The deficit occurs because of high imports and exports. This is to be reversed.
In this regard, the country may adopt a deflationary or dear money policy by raising the bank rate and restricting credit.
Under deflation, prices fall which makes exports attractive and imports relatively costlier.
This eventually leads to a rise in exports and a fall in imports.
The policy of money contraction or deflection keeps exchange rates unaffected and tries to correct the deficit in the Balance of payments through domestic changes.
However, deflation being inexpedient, its side effects are dangerous to a poor Nation. It creates more unemployment and poverty.
Again a developing economy has to adopt an expansionary rather than a contraceptive monetary policy to cater to developmental needs.
2. Exchange Rate Adjustment
A country can devalue its currency to make its exports more competitive and its imports more expensive, which can increase its exports and decrease its imports, thus improving its trade balance.
3. Exchange Depreciation
Exchange depreciation means the decline in the rate of exchange of one country in terms of another.
For example – Assume- the Indian rupee was exchanged for 65 Roubles of the Russian currency. If India experiences an adverse Balance of payments with regard to Russia, the Indian demand for Rouble will rise.
Consequently, the price of the Rouble in terms of the Rupee will be appreciated in its external value.
Thus, the rate of exchange of the Indian rupee in terms of rouble may change to 1 Rupee = 45 Roubles from 1 equals 45 balls this is known as 1 Rupee = 64 Roubles. This is known as Exchange Depreciation.
It is automatic and it helps in correcting a mild adverse Balance of payments.
This stimulates exports by making the domestic goods cheaper to the foreigners and thereby leading to a favorable balance.
However, this method is not feasible under the present system of IMF which prescribes the fixed exchange rate system.
4. Increase in Interest Rates
If a country’s interest rates are raised, it can attract foreign investment and increase the inflow of foreign currency, which can help to correct a balance of payments deficit.
5. Reduction in Government Spending
A country can reduce government spending to reduce the outflow of money from the country.
This can help to correct a balance of payments deficit.
Devaluation of currency is another way that makes exports attractive.
The term Devaluation means a reduction in the official rate at which one currency is exchanged for another.
It is an alternative to exchange depreciation.
Devaluation is undertaken when the currency is found to be unduly overvalued.
Devaluation makes the Goods cheaper for foreigners. Exports will rise and imports decline.
The Success of Devaluation, however, depends on certain following factors:
- The demand elasticity for the exports must be greater than Unity.
- The elasticity of supply for the imports should be greater than Unity.
- Devaluation should not be exceedingly adverse because it will not do anything.
- There should not be retaliative action from other Nations, that is, other nations should not have the corresponding Devaluation that nullifies each other’s gain.
- Devaluation of the country’s “terms of trade” should not be exceedingly adverse otherwise it will not gain anything from trade.
Moreover, these are the following ‘Drawbacks of Devaluation’:
- It may lead to ‘Inflationary’ tendencies in the internal economy.
- It is nothing but the acknowledgment of a country’s economic weakness.
- It puffs up the burden of Debt servicing.
- It takes considerable time to yield the expected results.
- Its effect is strongly purgative I.e. violent.
7. Exchange Control
Restriction on the use of foreign exchange by the central banks is called Exchange Control.
When exchange control is adopted, all the exporters have to surrender their foreign exchange earnings to Central Bank.
Under exchange control, the central bank releases foreign exchanges only for essential imports and conserves the rest of the balance.
This is the most direct method of curbing imports.
Exchange control, in General, deals with the balance of payments disequilibrium by suppressing the deficit that is only a symptom and not the Basic Trouble.
Exchange control deals with only the deficit, not its causes, and it may irritate those causes tending to create a more basic disequilibrium.
In other words, exchange control can prevent a complete breakdown, but it cannot eliminate a condition of disequilibrium.
Thus, exchange control offers no permanent solution to the problem of persistent disequilibrium.
It can, at best be justified only as a temporary measure, to gain time while other more fundamental adjustments made to restore equilibrium in the Balance of payments.
8. Export Promotion
A country can offer subsidies or tax incentives to its exporters to make its products more competitive in foreign markets.
9. Increase in Saving
If individuals and businesses in a country increase their savings, it can reduce the outflow of money from the country.
This can help to correct a balance of payments deficit.
10. Fiscal Policy- Import Duties
Under this policy, import traffic tariff duties are imposed so as to make the import dearer with the overall aim of checking imports.
Imports get reduced and the Balance of payments becomes favorable.
11. Import Policy (Import Quotes)
Under this mechanism, the government fixes a maximum quantity or value of a commodity to be imported.
This in turn reduces the deficit is reduced and thereby the Balance of payments, and the position is improved.
This measure has the immediate effect of checking imports as the marginal propensity to import becomes zero once the quota limit is reached.
To correct disequilibrium in the Balance of payments import quotes are assumed to be better than import duties.
The quota has the immediate effect of restricting imports as the marginal prosperity to import becomes zero, once the quota-limited is reached.
Thus, the effect of quotas on the quantitative restriction (QR) of imports is explicit. But the Balance of payments effects of import duties are not too certain.
12. Stimulating/Improving Export
To correct disequilibrium in the Balance of payments, it is necessary that exports should be increased, the government may adopt export programs for this purpose.
Export promotion programs include subsidies, tax concessions to exporters, marketing facilities, incentives for exporters, reducing export duties, etc.
Further, to encourage exports the level of costs in the country may have to be brought down.
Thus, may involve cutting down on wages and interest rates, and other incomes and also a contraction of currency to bring the prices down.
13. Structural Reforms
A country can implement structural reforms to improve its productivity and efficiency, such as investing in education and technology, improving infrastructure, and reducing bureaucratic barriers to trade.
14. International Borrowing
A country can borrow money from other countries or international organizations to finance its deficit.
However, this can lead to an increase in the country’s debt levels.
15. Foreign Loans
The government can also secure loans from foreign banks or foreign governments to reduce the deficit in the balance of payments.
Since the repayment of these loans is spread over a long period, This helps the government to remove the deficit in the Balance of payments.
During the currency of the loans, the government takes steps to improve its foreign exchange position.
16. Encouragement to Foreign Investment
The government induces foreigners to make an investment in the country offering them all sorts of investors incentives and concessions.
This provides the government with extra foreign exchanges which are utilized to reduce the deficit in the Balance of payments.
But while inviting the foreign capitalist to invest their capital within the country, the government sees to it that this does not produce any adverse repercussions on the economy.
17. Incentives to Foreign Tourists
The government may also encourage foreign tourists to visit the country in increasing numbers by offering them various facilities and constitutional travel.
This increases the foreign exchange earnings of the country with the help of which the deficit in the Balance of payments can be reduced.
18. Automatic Measures
The disequilibrium in the balance of payments may automatically disappear after some time when certain forces came into operation in the country.
For example – The disequilibrium in the Balance of payments of a country under the gold standard was automatically corrected through the inflow and outflow of gold.
If the balance of payments was unfavorable there was an outflow of gold from the country causing a contraction in the volume of currency and credit, and ultimately a fall in the domestic price level.
This encouraged exports, while it discouraged imports. The equilibrium in the BOP was automatically restored after some time.
Similarly, the equilibrium in the Balance of payments of a country on the paper standard was automatically corrected through fluctuations in its rate of exchange.
For example – If the country’s BOP was unfavorable, the demand for foreign exchange exceeded its supply, and consequently, the exchange value of its currency went down. The fall in its exchange value encouraged exports while it discouraged imports.
The Equilibrium in the BOP was automatically restored after the lapse of some time. The opposite process worked when the Balance of payments of the nation turned favorable.
The automatic measures discussed above did not produce the desired results in a short period.
Nor were they effective in dealing with a serious and fundamental disequilibrium in the BOP.
19. Miscellaneous Measures
These include- developing import-substituting Industries, postponing debt payments, checking on inflation, checking on smuggling, etc. All these may help in correcting disequilibrium in the Balance of payments.
To Sum up, some of the deficit in the balance of payments is not a desirable phenomenon for a nation.
The methods mentioned above aim at reducing imports and stimulating exports.
Of these, The trade measures are better and more effective. It produces immediate results.
The Government of a nation may use this method in combination with other methods to eliminate or reduce a chronic deficit in the Balance of payments.
20. International Financial Assistance
A country can seek assistance from international financial institutions such as the International Monetary Fund (IMF) to stabilize its economy and provide financing for its balance of payments
21. Capital control
Capital controls refer to the use of measures such as tariffs and quotas to restrict the flow of capital in and out of a country.
This can help to reduce the trade deficit and improve the balance of payments.
It is important to note that these measures should be implemented in a coordinated and balanced manner to avoid negative impacts on other aspects of the economy, such as inflation or economic growth.
Additionally, measures to correct BoP disequilibrium should be accompanied by efforts to address the underlying causes of the imbalance, such as low productivity or inadequate infrastructure, to ensure long-term sustainability.
It is important to note that each of these measures has its advantages and disadvantages, and their effectiveness depends on various factors such as the country’s economic conditions, the nature of the imbalance, and the policies of other countries.
Therefore, a combination of measures may be required to correct a balance of payments disequilibrium.
Iswari choudhury says
I leave application
Govind Singh Yadav says
Nice article, every points included and easy to understand, nicely written . Thanks
Jennifer theron says
happy to see you here
William mabhor Wuol says
This article is literally understandable
Jennifer theron says
any other question regarding this topic