Adjustment of Balance of Payments

Disequilibrium
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Presented by
Group no 4( roll no 30 to 40)
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Equilibrium in Balance of Payment of Nations
When 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.
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A): 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 disequilibrium
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Disequilibrium in BOP are caused by :

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


CAUSES FOR DISEQUILIBRIUM
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* 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.
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2. 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.
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3. Secular Disequilibrium
It 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.
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4. Structural Disequilibrium
Sometimes 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 Explosion
In the underdeveloped country aggregate consumption demand increases
due to rapid increase in population. As a result of this export surplus falls
down
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Foreign 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 BOP
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* 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 disequilibrium
Automatic correction Deliberate measures
Monetary measures Trade measures
Miscellaneous measures
Export promotion
Import control
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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.
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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
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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.
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* 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.
* Devaluation
In 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.
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* 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.
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* 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.
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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 you
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