METHODS OF CORRECTING DISEQUILIBRIUM IN B.O.P.

When such a situation of disequilibrium arises, the following measures are usually adopted.

i) Use of past reserves 

ii) Borrowings from IMF 

iii) Monetary and fiscal policy measures 

iv) Exchange rate adjustments. 

Let us learn them in detail. 

Use of Past reserves: A country may make use of past reserves to finance the BOP deficit provided such reserves are available. Such reserves consist of gold, foreign currencies and fund related assets i.e., reserve position with the IMF and holdings of special drawing rights. In recent years, increase in quotas and additional allocations of SDRs and expanded private capital flows have contributed to an overall increase in national reserves of several countries. 

Borrowing from IMF: Countries with disequilibrium in B.O.P. Can make use of IMF facilities. These are: 

1. Stand by loans 

2. Extended Fund Facilities (EFF) 

3. Structure Adjustment Facilities (SAF) 

4. Enlarged Structural Adjustment Facilities (ESAF) 

5. Compensatory and Contingency Financing Facilities (CCFF) 

6. Systemic Transformation Facilities (STF).

Monetary and fiscal policy measures: Monetary and fiscal policies are also important tools for influencing B.O.P. Conditions. A change in money supply brought about either through fiscal or monetary policies can bring about the required change in the level of total demand, which includes demand for imported goods and services. 

Exchange rate adjustments; Adjustments in exchange rate is an effective tool. A down- ward adjustment in exchange rate will make exports cheaper and imports dearer. In other words, as a result of such a policy, exports will be encouraged and imports will be discouraged and equilibrium will be restored. 

All these methods, however, suffer from certain limitations. Hence, managing a state of disequilibrium in B.O.P. continues to be a major problem which every country faces. The major problem is that a policy initiative taken for the sake of achieving equilibrium in B.O.P. comes into conflict with other, rather more endearing objectives, such as, economic growth, employment and price stability. Reconciling such conflicts continues to worry policy makers.

FACTORS AFFECTING BALANCE OF' PAYMENTS

The Current Account

A country's current account balance can significantly affect its economy; therefore, it is important to identify the factors that influence it. The most important factors are: 

I) Inflation 

ii) National Income 

iii) Government Restructures 

iv) Exchange Rates. 

Let us discuss them one by one. 

Inflation: If a country's inflation rate increases relative to the countries with which it trades, its current account would be expected to decrease. Due to higher prices at home, consumers and corporations with in the country will most likely purchase more goods overseas (due to high local inflation), while tile country's exports to other countries will decline. 

National Income: If a country's national income rises by a higher percentage than those of other countries, its current account is expected to decrease, other things being equal. As the real income level (adjusted for inflation) rises, so does consumption of goods. A percentage of that increase in consumption will most likely reflect an increased demand for foreign goods.

Government Restrictions: If a country's government imposes a tax on imported goods (often referred to as a tariff) the prices of foreign goods to consumers effectively increases. An increase in prices of imported goods relative to goods produced at home will discourage imports and is expected to increase the current account balance. In addition to tariffs, a government may reduce its imports by enforcing a quota, or a maximum limit on imports. 

Exchange Rates: Each country's currency is valued in terms of other currencies through the use of exchange rates, so that currencies can be exchanged to facilitate international transactions, The values of most currencies can fluctuate over time because of market and government forces, If a country’s current account balance decreases, other things being equal, goods exported by the country will become more expensive to the importing countries, if its currency strengthens, as a consequence, the demand for such goods will decline. For example, a refrigerator selling in the United State for $ 100 require a payment of Rs. 3500, if the dollar were worth Rs. 351- Ks. 1 = $0.028). Yet, if the dollar were worth Rs. 40/- (Rs. 1 = $ 0.025), it would take Rs, 4000 to buy the refrigerator. Which could discourage Indians to buy it, However, according to J-curve theory; a country's trade deficit worsens just after its currency depreciates because price effects will dominate the effect on volume of imports in the short run. That is the higher costs of imports will more than offset the reduced volume of imports. Thus, the J curve theory states that a decline in the value of home currency should be followed by a temporary worsening in the trade deficit before its longer term improvement.

The Capital Account

As with the current flows, government policies affect the capital account as well. A country's government could, for example, impose a special tax on income account by local investors who invested in foreign markets. A tax would discourage people from sending their funds for investment in the foreign markets and could therefore, increase the country's capital account. Capital flows are also influenced by capital controls of various types. Interest rates also affect the capital flows. A hike in interest rates relative to other countries may affect capital inflows from abroad. Similarly, a reduction in domestic rates may induce people to invest abroad. ' 

The anticipated exchange rate movements by investors in securities can affect the capital account. If a home currency is expected to strengthen, foreign investors may be willing to invest in the country’s securities to benefit from the currency movement. Conversely, a country's capital account balance is expected to decrease, if its home currency is expected to weaken, other things being equal. 

When attempting to assess why a country’s capital account changed and how it will change in future, all factors must be considered simultaneously. A particular country may experience a reduction in capital account even when its interest rates are attractive, if the home currency is expected to depreciate.

BALANCE OF PAYMENT DISEQUILIBRIUM

A nation's balance of payment is said to be in equilibrium when it is neither drawing upon its international reserves to make excess payments nor accumulating such reserves as a result of its receipts. In other words, when a country is not able to pay for its imports of goods and services from its export earnings, on accumulating reserves year after year, disequilibrium in balance of payments sets in. Policy initiatives are needed to restore equilibrium.

Disequilibrium in balance of payment may be short term or long term in nature. Short term disequilibrium, arises largely on account of cyclical factors. A crop failure leading to a sudden fall in export earnings may create a shortfall and consequently disequilibrium. 

Long term or structural disequilibrium arises on account of long term structural changes in the economy. Fall in demand of export products due to technological changes may bring about a decline in export proceeds. Decline in demand and prices for natural rubber on account of development of synthetics may be cited as an example. Such a situation call is remedied only by diversification of economy.

DEFICIT AND SURPLUS IN BALANCE OF PAYMENTS

You have learnt that BOP accounting is based on the principles of double entry book- keeping, meaning thereby that for every credit entry, there is a debit entry. Thus, a BOP account always balances. The difference between aggregate debit and credits is called balance. In case, debits exceed credit, balance is negative or deficit, when the credits exceed debits, the balance is positive or surplus. Obviously, the term, deficits or surplus cannot then refer to the entire BOP but sub set of accounts included in BOP. 

Where value of exports exceeds imports, the situation is referred as trade surplus or surplus on trade account. Excess of imports over exports results in trade deficit on trade account. 

The transactions appearing in a balance of payments can be classified in two categories, via autonomous transactions and accommodating or financing transactions, Autonomous transactions take place on their own, in response to their felt needs and are independent of situation in the balance of payments. Accommodating or financing transactions refer to the flows which take place in response to surplus or deficit in the balance of payments. For example, a country may incur or raise its liabilities or reduce its assets in order to pay for the deficit. A deficit in balance of payment exists when payments for autonomous or self motivated transactions exceed receipts. In case, there is a deficit or surplus, there have to be some compensatory transactions to balance the imbalance.

Autonomous and financing transactions are also referred to as above the line ad below the line respectively. 

There are several concepts of ‘balance’ in balance of payments. These are: 

Trade Balance: This is the balance on the merchandise trade account, i.e. Item 1 in the current account. 

Balance on goods and services: This is the balance between the export and import of goods and services. It is the net balance on item I and sub-items 1-6 of item III taken together. 

Current Account balance: This is the net balance on the entire current account items I+ll+IlI. When it is negative we have a current account deficit, when positive, a current account surplus. 

Balance on current account and long term capital: This is also called basic balance. This is supposed to indicate the long term trends in BOP. 

While changes in reserve assets are accurately measured, recording of other items is subject to errors arising out of data inadequacies, discrepancies of valuation and timing, erroneous reporting etc. These are reconciled through a fictitious head of account called 'Errors and Omissions'.

The capital Account & Other Accounts

The capital Account 

The account records the changes in the levels of international financial assets and liabilities. The various classifications within the capital account are private, banking and official. Distinction is also made between short term and long term capital flaws, loans with original maturity of more than one year are classified as long term flows. Long term foreign investment measures all capital investments made between countries, including both direct foreign investment and purchases of securities with maturities exceeding one year. Short term foreign investment measures flows of funds invested in securities with maturities of less than one year. Because of the short maturity, investors of such securities will often maintain their funds in a given country for only a short time, causing short term investment flows to be quite volatile over time.

 Private-capital Flows:

These flows consist of several types of transactions. Among them are: long term loans received by individuals and companies (other than banking institutions), investment by foreigners in the joint stock companies in India, repayment of long term loans by non- resident, obtained from residents, repatriation of Indian investments abroad, deposits in non-resident (external) rupee accounts and in foreign currency non-resident accounts. Capital outflows (debit entries) comprise investments by residents in shares and other financial assets abroad, repayment of foreign loans by residents, repatriation of foreign investments in India, long term loans made to non-residents and so forth. 

Short term capital flows on private account consists of short term borrowings and investments.

Banking Capital Flows:

Capital movements in banking sector covers changes in foreign assets and liabilities of commercial banks, whether privately owned or government owned and cooperative banks. Assets consist of balances held by banks with their foreign branches or correspondent banks abroad, and rupee assets representing loans granted by Indian banks to branches of foreign banks in India and correspondent banks. Liabilities consist of Indian banks' debit balances in their foreign accounts and credit balances held by nonresident banks and few other institutions with banks in India. Any increase in assets (or decrease in liabilities) will be a debit entry while a decrease in assets (or increase in liability) a credit. 

Official Capital flows: 

This category covers transactions affecting foreign financial assets and liabilities of the government of India and the Reserve Bank of India, excluding transactions relating to official reserve assets. Government of India's purchase and repurchase from the IMF are shown in a separate account. Loans received by the Government of India from foreign governments and international institutions are treated as credit entries and amortization or repayment of such loans as debit. 

Look at Table 3.2 which shows India’s balance of payments on Current Account and capital Account in recent years.

The Other Accounts
The remaining accounts in India’s BOP are set out in table 3.4.

The IMF account contains, as mentioned above, purchases (credits) and repurchases from the IMF. SDRs (Special Drawing Rights) are a reserve asset created by the JMF and allocated to member countries from time to time. Subject to IMF regulations, SDRs can be used to settle international payments between monetary authorities of member countries. .An allocation is a credit and the utilization is a debit. The reserves and Monetary Gold account increases (debits) and decreases (credits) in reserve assets. Reserve assets consist of RBI holdings of gold and foreign exchange (in the form of balances with foreign central banks and investments in foreign government’s securities) and Government’s holdings of SDRs.