Disequilibrium in Balance of Payments

We have noted above that the balance of payments is always in balances from accounting point of view. Besides, in the accounting procedure, a deficit in the current account is offset by a surplus in capital account resulting from either borrowing from abroad or running down the gold and foreign exchange reserves. Similarly, a surplus in the current account is offset by a corresponding deficit in capital account resulting from loans and bills to debtor country or by decline of  its gold and foreign exchange reserves. However, disequilibrium in the balance of payments does arise because total receipts during the reference period need not be necessarily equal to the total payments. When total receipts do not match with total payment of the accounting period, this is a position of disequilibrium in the balance of payments. The final balance of payments position is obtained in the manner described below.

For assessing the over-all balance of payments position, the total receipt and total payments arising out of transfer of goods and services and long-run capital movements are taken into account. All the transactions are regrouped into autonomous and induced transactions. Autonomous transactions take place on their own all account of peoples desire to consume more or to make a larger profit. For example, export and imports of items in current account are undertaken with a view to, make profit or consume more goods. Another autonomous item in the current account is gift or donations. They are voluntary and deliberate. In the capital account, export and import of long-term capital are autonomous transactions. In addition, the short-term capital movements motivated by the desire to invest abroad for higher return fall in the category of autonomous transactions. Thus all exports and imports of goods and services, long-term and short-term capital movements motivated by the desire to earn higher returns abroad or to give gifts and donation are the autonomous transactions. Exports and imports take place irrespective of other transactions included in the balance of payments accounts. Hence, these are autonomous transactions. If exports (Xg) equal imports (Mg) in value, there will be no other transaction. However, if Xg is less than Mg, it leads to short-run capital movements, e.g., international borrowing or lending. Such international borrowings or lending are not undertaken for their own sake, but for making payment for the deficit in the balance of trade. Hence, these are called induced transactions. They involve accommodating capital flows. On the other hand, the short-term capital movement’s viz., gold movements it and accommodating capital movements on accounts of the autonomous transactions are induced transactions. These transactions lead to reduction in the gold and foreign exchange reserves of the country.

In the assessment of balance of payments position only autonomous transactions are taken into account. The total receipt and payments resulting from the autonomous transaction determine the deficit or surplus in the balance of payments. If total receipts and payments are unequal, the balance of payments is in disequilibrium. If the total payments exceed the total receipts, the balance or payment shows deficit. On the contrary, if receipts from autonomous transactions exceed the payments for autonomous transactions, the balance of payments is in surplus. Naturally, if both are equal, there is neither deficit nor surplus, and the balance of payments is in equilibrium. From the policy point of view, the depletion in the gold and foreign exchange reserves is generally taken as an indicator of balance of payments running into deficit, which is a matter of concern for the government. However, if reserves are plentiful and the government has adopted a deliberate policy to run it down, then the deficit in the balance of payments is not a healthy sign for the economy. Besides, the disequilibrium of surplus nature except the one that might cause inflation is not a serious matter as the disequilibrium of deficit nature. We will be therefore, concerned here mainly with the deficit kind of disequilibrium in the balance of payments.

Causes of BoP Disequilibrium

The deficit kind of disequilibrium in the balance of payments arises when a country’s autonomous payments exceed its autonomous receipts. The autonomous payments arise out of imports of goods and services and export of capital. Similarly, autonomous receipts result from the merchandise exports and import of capital. It may therefore be said that disequilibrium of deficit nature arises when total imports exceed total exports. However, imports and exports do not determine themselves. The volume and value of imports and exports are determined by a host of other factors. As regards the determinants of imports, the total import of country depends upon three factors: (i) internal demand for foreign goods, which largely depends on the total purchasing power of the residents of the importing country, (ii) the prices of imports and their domestic substitutes, and (iii) people’s preference for foreign goods. Similarly, the total export of a country depends on (i) foreign demand for its goods and services, (ii) competitiveness of its price and quality, and (iii) exportable surplus.

Under static conditions, these factors remain constant. Therefore, equilibrium in the balance of payments, once achieved, remains stable. However, under dynamic conditions, factors that determine imports and exports keep changing, sometimes gradually but often violently and unexpectedly. The changes differ in their duration and intensity from country to country and from time to time. The changes, which occur as a result of disturbances ,in the domestic economy and abroad, create conditions for dis-equilibrium in the balance of payment.

1. Price Changes and Disequilibrium

The first and the major cause of disequilibrium in the balance of payment is the change in the price level. Price changes may be inflationary or deflationary. Deflation normally causes surplus in the balance of payment. The balance of payments surplus does not cause a serious concern from the country’s point of view. It may, however lead to wasteful expenditure and mal-allocation of resources. On he other hand, inflationary changes in prices causes deficits in the balance of payments. The balance of payments deficit result in increased indebtedness, depletion of gold reserves. loss of employment and distortions in the domestic economy and causes other economic problems in the deficit countries. Therefore, we will discuss only the impact of inflationary price changes on the balance of payments position.

Inflation causes a change in the relative prices of imports and exports. While exchange rate remains same, inflation causes increase in imports because domestic prices become relatively higher than the import prices. On the other hand, inflation leads to decrease in exports because of decrease in foreign demand due to increase in domestic prices. The increase in imports depends also on price-elasticity of demand for imports in the home market and decrease in the exports depends on the price-elasticity of foreign demand for home-products. In case price-elasticity of imports and exports is not equal to zero, imports are bound to exceed the exports. As a result, there will be a deficit in the balance of payments. If inflationary conditions perpetuate, it will produce long-run disequilibrium. If the size of deficit is large and disequilibrium is inflexible, it is termed as a fundamental disequilibrium.  The price changes or fluctuations may be local, confined to one or few countries or it may be global as it happened in the world economy in 1930s. If price fluctuations take the form of business cycle, most countries face depression and inflation almost simultaneously. Since economic size of the nations differs, their imports are affected in varying degrees. Deficits and surpluses in the balance of payment vary from moderate to large. The countries with higher marginal propensity to import accumulate larger deficits during inflationary phase of trade cycle and a moderate deficit or even surplus, during depression. Such disequilibrium is known as cyclical disequilibrium. This is however only a theoretical possibility. Since little is known about the marginal propensities to import, any generalization would be unwise.

3. Structural Changes and Disequilibrium

Structural changes, in an economy are caused by factors, such as, (i) depletion of the cheap natural resources (ii) change in technology with which a country is not in a position to keep pace, i.e., technology lag and, (iii) change in consumers taste and preference. Such changes incapacitate exporting countries and they find it difficult to face competition in the international market, due to either high cost of production or lack of foreign demand.

All such changes bring change in demand and supply conditions. If size of foreign trade is fairly large, then the balance of payments is adversely affected. The ultimate result is disequilibrium in the balance of payments. It is called structural disequilibrium. The structural disequilibrium may also originate from the discovery of new resources, which may invite foreign capital in a large measure. The large-scale capital inflow may turn the balance of payments deficit into a surplus.

3. Other Factors

In addition to the fundamental factors responsible for disequilibrium in the balance of payments, there are certain other factors, which may cause temporal disequilibrium, Some of them are as follows:

  • Disturbances or crop failure particularly in the countries, producing primary goods.
  • Rapid growth in population leading to large-scale imports of food materials.
  • Ambitious development projects requiring heavy imports of technology, equipments,machinery and technical know-how.
  • Demonstration-effect of advanced countries on the consumption pattern of less developed countries.

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