Disequilibrium in Balance of Payment and Methods To Correct PDF Balance Of Payments Current Account

These development programs are time taking process and therefore requires continuous import for a long time which causes disequilibrium. Disequilibrium caused on a temporary basis for a short period, say one year is called short run disequilibrium. Such disequilibrium does not pose a serious threat as it can be overcome within a short run. Such an disequilibrium may be caused due to international borrowing and lending. When a country goes for borrowing or lending it leads to short run disequilibrium.

Essentially, it covers all monetary exchange, which reflects the trading of both goods and services, as well as investments, as well as transfers. The system is such that all inflows of foreign currency, from either export or foreign direct investment, will balance out to outflows in the form of imports or foreign assistance. Although BoPs are typically imbalanced, theoretically they should always balance when all factors are taken into account. The balance or equilibrium in Balance of Payments means that the demand for foreign exchange is equal to the supply. On the contrary, disequilibrium is a situation where the balance of payments does not equal zero, meaning that there is a surplus or deficit. While specific accounts (like the current account) can show a deficit or surplus, the overall balance of payments always balances.

Balance of Payments Disequilibrium and Fixed Exchange Rates

In a floating exchange rate, the two components of the Balance of Payments should balance each other types of disequilibrium in balance of payment out. Then in a floating exchange rate, the financial account should have a surplus of £52bn. This is because financial outflows must be matched by financial inflows. Disequilibrium occurs due to factors such as excessive imports, foreign debt, inflation, and political instability. When inflows and outflows do not naturally balance, this creates an imbalance in the economy. Excessive external borrowing is another main factor responsible for causing a surplus or deficit in country’s balance of payments.

For example, if a country has a persistent current account deficit, it can employ measures to reduce imports, devalue its currency, or increase exports. It takes place due to structural changes in the economy affecting demand and supply relations in commodity and factor market. Structural disequilibrium in balance of payments persists for relatively longer periods; as it is not easy to remove structural imbalance in the economy. Balance of Payments (BOP) is a statistical statement that systematically summarizes all economic transactions between the residents of a given country and the rest of the world during a specific period. These transactions consist of imports and exports of goods, services, money transfer, and financial capital. Disequilibrium occurs when the balance of payment accounts does not balance naturally.

It is the largest component of a country’s balance of payments on the current account. If it imports more than it exports, it definitely has a trade deficit. The sustained or secular disequilibrium refers to a situation when, the BoP disequilibrium persists for long periods due to certain secular trends in the economy. It is seen in the developed countries where, the disposable income is generally very high and so the aggregate demand is also very high. But due to higher aggregate demands, the production costs are also very high. This would result in higher prices, which may result in the imports being much higher than exports.

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By virtue of its control over the use of foreign exchange, the government can control imports and also increase its foreign currency reserves. Cyclical fluctuations in the business activity bring depression, stagnant and boom stage in world trade. Whenever there is a depression/recession in foreign countries, our exports will fall due to low demand and there will be reduction in foreign exchange earnings. Similarly, the boom condition in foreign countries will increase our exports and our capacity to earn foreign exchange will increase.

MEASURES TO CORRECT DISEQUILIBRIUM IN BALANCE OF PAYMENTS

In other words, the balance of payments of a country is said to be in equilibrium when the demand for foreign exchange in exactly equivalent to the supply of it. There will be a deficit in the balance of payments when the demand for foreign exchange exceeds its supply, and three will be a surplus when the supply of foreign exchange exceeds the demand. A number of factors may cause disequilibrium in the balance of payments. It records all economic transactions between residents of a country and the rest of the world in a particular period. This indicates the demand and supply of goods, services, and financial assets by a country’s residents. The balance of payments includes the balance of trade, net income, and direct payments.

It can occur when autonomous receipts and payments are not equal, leading to a surplus or deficit. Cyclical fluctuations and exchange rate changes can also cause disequilibrium. Countries employ various measures to correct an unfavorable balance of payments deficit. The Balance of Payments (BoP) is a comprehensive statement that summarizes all the economic transactions between a country and the rest of the world during a specific period, typically a year. These transactions include goods, services, and even capital movements such as investments. The BoP’s primary components are the current account, comprising trade in goods and services, and the capital and financial account, encompassing investments and financial transfers.

• The recipients of foreign exchange, like exporters, are required to surrender foreign exchange to the government/central bank in exchange for domestic currency.
• The Understanding of the Balance of Payments is crucial in international economics, helping to evaluate a country’s economic performance and predict potential issues.
• In a perfect scenario, balance of payment should be zero which simply means value of imports is equal to value of exports.
• Note, how if one country has a large surplus on the current account (Germany).
• Developing countries undertaking large development and investment projects need to import funds, capital, skilled manpower, and technology from developed countries.
• That implies that a deficit in the current account may cause devaluation through high demand for foreign exchange compared to supply.

Disequilibrium in Balance of Payments

A current account deficit, for instance, is offset by inflows in the capital or financial accounts. That implies that a deficit in the current account may cause devaluation through high demand for foreign exchange compared to supply. Conversely, a surplus might lead to the appreciation of the currency due to increased foreign exchange reserves. A developing country in its initial stages may import large amount of capital & hence its imports would exceeds exports.

Current account deficit suggests wider disequilibrium in the Economy

Monetary disequilibrium, takes place on account of inflation or deflation. The prices of the products in the domestic market rises, and therefore, export items will become expensive. Inflation also results in to increase in money income with the people, which in turn may increase demand for imported goods. Technological disequilibrium in balance of payments is caused by various technological changes involve inventions or innovations of new goods or new technique of production.

If the UK imports more goods and services than we export – then we have a deficit on the current account. A significant deficit on the current account is generally referred to as disequilibrium. The capital account describes all the international capital transfers. It is comprised of debt forgiveness, acquisitions and disposals of non-financial assets, and a flow of funds from one country to another in investments. An increase in price level and income will bring an increase in the value of the country’s exports due to which it will decline.

It prevails for a long period of time i.e. when the disequilibrium is persistent & long run oriented, it is called long run disequilibrium The IMF terms such disequilibrium as “Fundamental Disequilibrium”. The demonstration effect refers to the consumption pattern of developed countries being imitated by developing or under-developed countries. When peoples want to raise the level of a pattern of their consumption, the need for importing more goods arises.

Difference Between Balance of Trade and Balance of Payments

• Volatile inflows like portfolio investment also referred as hot money can threaten the stability of the economy.
• It refers to the difference between the value of a nation’s exports and the value of its imports.
• It is possible that different phases of trade cycles like depression, prosperity, boom, recession, etc, may disturb terms of trade and cause disequilibrium in balance of payments.
• Balance of payment is an account of all economic and financial transactions of a country with the rest of the world.
• The document discusses disequilibrium in a country’s balance of payments.
• Whenever there is a depression/recession in foreign countries, our exports will fall due to low demand and there will be reduction in foreign exchange earnings.

The imbalances tend either to be sustained surpluses or deficits, whereby an economy may get destabilized and, consequently, have serious consequences, from currency devaluation to inflation. Under the exchange control, the government via the RBI assumes complete control over the foreign exchange reserves and earnings of the country. The recipients of foreign exchange, like exporters, are required to surrender foreign exchange to the government/central bank in exchange for domestic currency.

When this becomes chronic, there emerges a secular deficit in its balance of payments. Technological advancements, growth of population etc. also contribute to fundamental disequilibrium. It refers to the difference between the value of a nation’s exports and the value of its imports.

Rapidly increasing population in countries is another important reason which leads to disequilibrium in BOP. With the growing population, it becomes essential for countries to imports goods for meeting the needs of their people. One of the best ways to fund the CAD is through non-debt creating and long-term inflows such as FDI. Volatile inflows like portfolio investment also referred as hot money can threaten the stability of the economy. So, most commonly, the Currency devaluation takes place to correct the BoP deficit.