Disequilibrium in the balance of payments occurs when there is an imbalance between a country’s payments to and receipts from other countries.
The balance of payments is a record of all the financial transactions between a country and the rest of the world, including imports and exports of goods and services, capital flows, and financial transfers.
If a country is importing more than it is exporting, it will have a current account deficit, which means that it is spending more foreign currency than it is earning. This can lead to a depletion of foreign exchange reserves and a depreciation of the country’s currency.
Conversely, if a country is exporting more than it is importing, it will have a current account surplus, which means that it is earning more foreign currency than it is spending.
Types of Disequilibrium in Balance of Payments
Broadly speaking, there are seven different types of disequilibrium in the BOP:
1. Cyclical Disequilibrium
in the BOP arises due to the influences of cyclical fluctuations.
Cyclical Disequilibrium in the BOP occurs, because:
- The business cycle/Trade cycle follows different paths and patterns in different countries.
- There are no identical timing and periodicity of occurrence of cycles in different nations.
- No identical stabilization programs and measures are adopted by different states.
- The income Elasticities of demand for imports in different nations are not identical.
- Price Elasticities of demand for imports differ in different nations. Deficit and surplus alternatively take place during the depression and prosperity phase of a cycle. The balance of payments equilibrium is automatically set forth over the complete cycle.
2. Secular Disequilibrium
Secular disequilibrium in the balance of payments is a long-term, phenomenon, caused by persistent, deep-rooted dynamic changes that slowly take place in the economy over a long period of time.
It may be caused by changes in several dynamic forces or factors such as capital formation, population growth, technological changes, the growth of markets, changes in resources, etc a newly developing nation, For instance, needs huge Investments which far exceed exports. It’s domestic savings. Its imports also tend to exceed exports.
If sufficient foreign capital is not forthcoming it may suffer from a secular deficit in its balance of payments. On the contrary, a mature economy may have surplus capital and a favorable balance of trade.
If the outflow of capital is sufficient or restricted, a secular surplus in the balance of payments may accrue to the country.
3. Structural Disequilibrium
Structural disequilibrium arises from structural changes occurring in a few sectors of the economy at home or abroad which may alter the demand for supply conditions for exports or imports or both.
A change in foreign demand for exports can arise from a change in technology, and the invention of a cheaper substitute.
Similarly, a change in supply can arise from the dislocation of production because of strikes or other political punches, or natural calamities. Service income from abroad may also decline because of a change in the economic situation or the economic policy of other Nations.
Structural changes are also produced by variations in the rate of international capital movement.
Structural disequilibrium at the factor level takes place when a country’s factor prices deviate disproportionately from the factor endowment.
4. Temporary Disequilibrium
A country’s Balance of payments is of a temporary nature lasting for a short period which may occur once in a while.
Any factor which temporarily causes one-sided movement in the items constituting the Balance of payments is sufficient to cause a disequilibrium.
This is subject to reversal within a limited period.
5. Current Account Disequilibrium
This type of disequilibrium occurs when there is a deficit or surplus in a country’s current account.
The current account records all transactions related to trade in goods and services, as well as income flows, such as interest and dividends.
A current account deficit means that a country is importing more goods and services than it is exporting, or that it is paying more in income flows than it is receiving.
This results in a net outflow of the country’s currency and a reduction in its foreign exchange reserves. A current account surplus, on the other hand, means that a country is exporting more goods and services than it is importing or that it is receiving more income flows than it is paying.
This results in a net inflow of the country’s currency and an increase in its foreign exchange reserves.
6. Capital Account Disequilibrium
This type of disequilibrium occurs when there is a deficit or surplus in a country’s capital account.
A capital account deficit means that a country is borrowing more capital from foreign lenders than it is investing abroad. This results in a net outflow of the country’s currency and can lead to a decline in its foreign exchange reserves.
A capital account surplus, on the other hand, means that a country is investing more capital abroad than it is borrowing from foreign lenders.
This results in a net inflow of the country’s currency and can lead to an increase in its foreign exchange reserves.
7. Fundamental or Long Run Disequilibrium
The long-term disequilibrium thus refers to a deep-rooted, persistent deficit or surplus in the Balance of payments of a country.
It is a secular disequilibrium emerging on account of the chronologically accumulated short-term disequilibrium deficit or surpluses.
It endangers the exchange stability of the country concerned.
Especially, a long-Run deficit in the Balance of payments of a country tends to deplete its Foreign Exchange Reserves and the country may also be unable to raise any more loans from foreigners on account of such persistent deficits.
A Fundamental equilibrium is said to exist when autonomous income and expenditure accord with each other over a given period without either necessitating import restrictions or causing excessive unemployment.
In practice, it is difficult to determine whether these criteria are fulfilled.
Underdeveloped nations generally suffer from long-term disequilibrium in the Balance of payments owing to a large number of causes and many Complex factors interacting with one another.
The root cause of disequilibrium in the balance of payments of this economy is the huge development and investment programs in operation in this economy.
They require the Import of huge quantities of capital goods, technical know-how, and essential raw materials to carry on the development programs.