CAUSES OF

DISEQUILIBRIUM IN

BALANCE OF

PAYMENT

1

INTRODUCTION

Balance of payments (BoP) accounts are an accounting record of all monetary

transactions between a country and the rest of the world. These transactions

include payments for the country's exports and imports

of goods, services, financial capital, and financial transfers. The BoP accounts

summarize international transactions for a specific period, usually a year, and are

prepared in a single currency, typically the domestic currency for the country

concerned. Sources of funds for a nation, such as exports or the receipts of loans

and investments, are recorded as positive or surplus items. Uses of funds, such as

for imports or to invest in foreign countries, are recorded as negative or deficit

items.

When all components of the BOP accounts are included they must sum to zero

with no overall surplus or deficit. For example, if a country is importing more

than it exports, its trade balance will be in deficit, but the shortfall will have to be

counterbalanced in other ways – such as by funds earned from its foreign

investments, by running down central bank reserves or by receiving loans from

other countries.

While the overall BOP accounts will always balance when all types of payments

are included, imbalances are possible on individual elements of the BOP, such as

the current account, the capital account excluding the central bank's reserve

account, or the sum of the two. Imbalances in the latter sum can result in surplus

countries accumulating wealth, while deficit nations become increasingly

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indebted. The term "balance of payments" often refers to this sum: a country's

balance of payments is said to be in surplus (equivalently, the balance of

payments is positive) by a certain amount if sources of funds (such as export

goods sold and bonds sold) exceed uses of funds (such as paying for imported

goods and paying for foreign bonds purchased) by that amount. There is said to be

a balance of payments deficit (the balance of payments is said to be negative) if

the former are less than the latter.

Under a fixed exchange rate system, the central bank accommodates those flows

by buying up any net inflow of funds into the country or by providing foreign

currency funds to the foreign exchange market to match any international outflow

of funds, thus preventing the funds flows from affecting the exchange

rate between the country's currency and other currencies. Then the net change per

year in the central bank's foreign exchange reserves is sometimes called the

balance of payments surplus or deficit. Alternatives to a fixed exchange rate

system include a managed float where some changes of exchange rates are

allowed, or at the other extreme a purely floating exchange rate (also known as a

purely flexible exchange rate). With a pure float the central bank does not

intervene at all to protect or devalue its currency, allowing the rate to be set by the

market, and the central bank's foreign exchange reserves do not change.

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BALANCE OF PAYMENT ACCOUNT

Trade Account Balance

It is the difference between exports and imports of goods, usually referred as

visible or tangible items. Till recently goods dominated international trade. Trade

account balance tells as whether a country enjoys a surplus or deficit on that

account. An industrial country with its industrial products comprising consumer

and capital goods always had an advantageous position. Developing countries

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with its export of primary goods had most of the time suffered from a deficit in

their balance of payments. Most of the OPEC countries are in better position on

trade account balance.

The Balance of Trade is also referred as the 'Balance of Visible Trade' or 'Balance

of Merchandise Trade'.

Current Account Balance

It is difference between the receipts and payments on account of current account

which includes trade balance. The current account includes export of services,

interests, profits, dividends and unilateral receipts from abroad, and the import of

services, interests, profits, dividends and unilateral Payments to abroad. There can

be either surplus or deficit in current account. The deficit will take place when the

debits are more than credits or when payments are more than receipts and the

current account surplus will take place when the credits are more than debits.

Capital Account Balance

It is difference between the receipts and payments on account of capital account.

The capital account involves inflows and outflows relating to investments, short

tern borrowings/lending, and medium term to long term borrowing/lending. There

can be surplus or deficit in capital account. The surplus will take place when the

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credits are more than debits and the deficit will take place when the debits are

more than credits.

Foreign Exchange Reserves

Foreign exchange reserves shows the reserves which are held in the form of

foreign currencies usually in hard currencies like dollar, pound etc., gold and

Special Drawing Rights (SDRs). Foreign exchange reserves are analogous to an

individual's holding of cash. They increase when the individual has a surplus in

his transactions and decrease when he has a deficit. When a country enjoys a net

surplus both in current account & capital account, it increases foreign exchange

reserves. Whenever current account deficit exceeds the inflow in capital account,

foreign exchange from the reserve accounts is used to meet the deficit If a

country's foreign exchange reserves rise, that transaction is shown as minus in that

country's balance of payments accounts because money is been transferred to the

foreign exchange reserves.

Foreign exchange reserves (forex) are used to meet the deficit in the balance of

payments. The entry is in the receipt side as we receive the forex for the particular

year by reducing the balance from the reserves. When surplus is transferred to the

foreign exchange reserve, it is shown as minus in that particular year's balance of

payment account. The minus sign (-) indicates an increase in forex and plus sign

(+) shows the borrowing of foreign exchange from the forex account to meet the

deficit.

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Errors and Omission

The errors may be due to statistical discrepancies & omission may be due to

certain transactions may not be recorded. For eg: A remittance by an Indian

working abroad to India may not yet recorded, or a payment of dividend abroad

by an MNC operating in India may not yet recorded or so on. The errors and

omissions amount equals to the amount necessary to balance both the sides.

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COMPOSITION OF BALANCE OF PAYMENT SHEET

BOP the two principal parts of the BOP accounts are the current account and

the capital account.

The current account shows the net amount a country is earning if it is in surplus,

or spending if it is in deficit. It is the sum of the balance of trade (net earnings on

exports minus payments for imports), factor income (earnings on foreign

investments minus payments made to foreign investors) and cash transfers. It is

called the current account as it covers transactions in the "here and now" - those

that don't give rise to future claims.

The Capital Account records the net change in ownership of foreign assets. It

includes the reserve account (the foreign exchange market operations of a

nation's central bank), along with loans and investments between the country and

the rest of world (but not the future regular repayments/dividends that the loans

and investments yield; those are earnings and will be recorded in the current

account). The term "capital account" is also used in the narrower sense that

excludes central bank foreign exchange market operations: Sometimes the reserve

account is classified as "below the line" and so not reported as part of the capital

account.

Expressed with the broader meaning for the capital account, the

BOP identity assumes that any current account surplus will be balanced by a

capital account deficit of equal size - or alternatively a current account deficit will

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be balanced by a corresponding capital account surplus.

The balancing item, which may be positive or negative, is simply an amount that

accounts for any statistical errors and assures that the current and capital accounts

sum to zero. By the principles of double entry accounting, an entry in the current

account gives rise to an entry in the capital account, and in aggregate the two

accounts automatically balance. A balance isn't always reflected in reported

figures for the current and capital accounts, which might, for example, report a

surplus for both accounts, but when this happens it always means something has

been missed—most commonly, the operations of the country's central bank—and

what has been missed is recorded in the statistical discrepancy term (the balancing

item).

An actual balance sheet will typically have numerous sub headings under the

principal divisions. For example, entries under Current account might include:

Trade – buying and selling of goods and services

Exports – a credit entry

Imports – a debit entry

Trade balance – the sum of Exports and Imports

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Factor income – repayments and dividends from loans and investments

Factor earnings – a credit entry

Factor payments – a debit entry

Factor income balance – the sum of earnings and payments.

Especially in older balance sheets, a common division was between visible and

invisible entries. Visible trade recorded imports and exports of physical goods

(entries for trade in physical goods excluding services is now often called

the merchandise balance). Invisible trade would record international buying and

selling of services, and sometimes would be grouped with transfer and factor

income as invisible earnings.

The term "balance of payments surplus" (or deficit — a deficit is simply a

negative surplus) refers to the sum of the surpluses in the current account and the

narrowly defined capital account (excluding changes in central bank reserves).

Denoting the balance of payments surplus as BOP surplus, the relevant identity is

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DISEQUILIBRIUM

Though the credit and debit are written balanced in the balance of payment

account, it may not remain balanced always. Very often, debit exceeds credit or

the credit exceeds debit causing an imbalance in the balance of payment account.

Such an imbalance is called the disequilibrium. Disequilibrium may take place

either in the form of deficit or in the form of surplus.

Disequilibrium of Deficit arises when our receipts from the foreigners fall below

our payment to foreigners. It arises when the effective demand for foreign

exchange of the country exceeds its supply at a given rate of exchange. This is

called an 'unfavorable balance'.

Disequilibrium of Surplus arises when the receipts of the country exceed its

payments. Such a situation arises when the effective demand for foreign exchange

is less than its supply. Such a surplus disequilibrium is termed as 'favorable

balance'.

While the BOP has to balance overall, surpluses or deficits on its individual

elements can lead to imbalances between countries. In general there is concern

over deficits in the current account. Countries with deficits in their current

accounts will build up increasing debt and/or see increased foreign ownership of

their assets.

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The types of deficits that typically raise concern are

A visible trade deficit where a nation is importing more physical goods than it

exports (even if this is balanced by the other components of the current

account.)

An overall current account deficit.

A basic deficit which is the current account plus foreign direct investment

(but excluding other elements of the capital account like short terms loans and

the reserve account.)

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TYPES OF DISEQUILIBRIUM IN THE BALANCE OF

PAYMENT

1. Structural Disequilibrium

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.

Some of the important causes of structural disequilibrium are as follows :-

1. If the foreign demand for a country's products decline due to the discovery of

cheaper substitutes abroad, then the country's export will decline causing a

deficit.

2. If the supply position of a country is affected due factors like crop failure,

shortage of raw-materials, strikes, political instability, etc, then there would be

the deficit in the balance of payments.

3. A shift in demand due to the changes in tastes, fashions, income, etc, would

increase or decrease the demand for imported goods causing a disequilibrium in

the balance of payments.

4. Changes in the rate of international capital movements may also cause

structural disequilibrium.

5. A war also results in structural changes which may affect not only goods but

also factor of production causing a disequilibrium in balance of payments.

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2. Cyclical Disequilibrium

When disequilibrium is caused due to the changes in trade cycles, it is termed as

cyclical disequilibrium. 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.

For instance, during boom period, imports may increase considerably due to

increase in demand for imported goods. During recession and depression, imports

may be reduced due to fall in demand on account of reduced income. During

recession exports may increase due to fall in price. During boom period, a country

may face deficit in its BoP position on account increase in imports. However,

during recession its export may increase, and as such BoP position may show

surplus.

Also, the importing countries may face cyclical changes. For instance, there may

be recession in the importing countries, which in turn would reduce demand for

imports. Therefore, the demand for exports will decline and the exporting country

may face a trade deficit, which in turn may affect BoP positions.

3. Technological Disequilibrium

Technological disequilibrium in balance of payments is caused by various

technological changes involve inventions or innovations of new goods or new

technique of production. These technological changes affect the demand for

factors and goods.

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A technological change will give comparative advantage to the innovating

country leading to the increase in exports or a decline in imports. This will create

disequilibrium in the balance of payments.

4. Short run 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. Such disequilibrium is justified as

they do not pose a serious threat.

Short run disequilibrium may also be caused when a country's imports exceeds

exports in a particular year. Such disequilibrium is not justified as it has the

potentiality to develop in to a crisis in time. The crisis in India in 1990-91 is

nothing but the development of short run disequilibrium. If the short run

disequilibrium is persistant & occurs repeatedly; it may pave the way for long run

disequilibrium.

5. Long run or Secular Disequilibrium

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".

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Long-run or fundamental disequilibrium refers to a persistent deficit or a surplus

in the balance of payments of a country. It is also known as secular

disequilibrium.

When there is a continuous increase in the stock of gold and foreign exchange

reserves. there is a persistent surplus & vise-versa.

Permanent changes in the conditions of demand and supply of exports and

imports cause fundamental disequilibrium. A permanent deficit or surplus may

make a country debtor or creditor causing a fundamental disequilibrium.

A developing country in its initial stages may import large amount of capital &

hence its imports would exceeds exports. When this becomes chronic, there

emerges a secular deficit in its balance of payments. Deep rooted dynamic

changes like capital formation, innovations. technological advancements, growth

of population etc. also contribute to fundamental disequilibrium.

When there is a series of short-run disequilibrium in a country's balance of

payments, ultimately it would lead to fundamental disequilibrium.

6. Monetary Disequilibrium

Monetary disequilibrium, takes place on account of inflation or deflation. Due to

inflation. the prices of the products in the domestic market rises, and therefore,

export items will become expensive. Such a situation may affect the BoP

equilibrium. Inflation also results in to increase in money income with the people,

which in turn may increase demand for imported goods. As a result imports may

turn Bop position in disequilibrium.

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CAUSES OF DISEQUILIBRIUM IN BALANCE OF

PAYMENT

POPULATION GROWTH

Most countries experience an increase in the population and in some like

India and China the population is not only large but increases at a faster rate. To

meet their needs, imports become essential and the quantity of imports may

increase as population increases. It adversely affect balance of payments in the

poor countries. Rapid growth of population in countries like India increases

imports and decreases the capacity to export.

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DEVELOPMENT PROGRAMMES

The main reason for adverse balance of payments in the developing countries is

the huge investment in development schemes in these countries. The propensity to

import of the developing countries increases for want of capital for

industrialization. The exports, on the other hand, may not increase because these

countries are traditionally primary producing countries. Moreover the volume of

exports may fall because newly created domestic industries may need them. All

this leads to structural changes in the balance of payment resulting in structural

disequilibrium.

Developing countries which have embarked upon planned development

programmes require to import capital goods, some raw materials which are not

available at home and highly skilled and specialized manpower. Since

development is a continuous process, imports of these items continue for the long

time landing these countries in a balance of payment deficit.

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DEMONSTRATION EFFECT

The concept of the demonstration effect in consumption, originally formulated by

Duesenberry is an interpersonal frame work, has beeb applied more recently by

Nurkse to international economics. In discussing the problems of capital

formation in underdeveloped countries, nurkse sees I the demonstration effect a

source of much difficulty. He asserts “the great and growing gaps, between the

income levels and therefore living standards of different countries, combined with

increasing awareness of these gaps, may tend to push up up the general propensity

to consume of the poorer nation, reduce their capacity to save, and incidentally

strain their balance of payments. Insofar as these tendencies do materialize, the

demonstration effect on the international plane plays the role of a villain because

it reduces the supply of investible funds in underdeveloped countries where an

urgent need of capitl exists.

When the people in the less developed countries imitate the consumption pattern

of the people in the developed countries, their import will increase. Their export

may remain constant or decline causing disequilibrium in the balance of

payments.

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NATURAL FACTOR

In today's increasingly interconnected economy, the economic fallout from a

natural disaster is rarely relegated to the geographic area that it hits. In fact, even

natural disasters that take place thousands of miles away can shake up your

portfolio here at home.

One of the biggest problems for areas affected by natural disasters is business

disruption. With road, communication infrastructure, and building damage

common after sizable disasters, it's not uncommon for local businesses to be shut

down for some time after the aftershocks settle. On a grand scale, that's what

happened after Hurricane Katrina ravaged the Gulf coast back in 2005 – as

companies reeled from catastrophic losses, millions of workers in Louisiana,

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Texas and Mississippi were left jobless, compounding the already staggering

poverty problem in the region.

With this mass unemployment came a severe cutback in consumer spending (at

the few places that were open for business) and – consequently – tax revenues

needed to aid in the rebuilding efforts. Furthermore, the international impact was

especially felt throughout the energy sector as oil prices escalated due to

destroyed rigs and refineries. (Learn more in Using Consumer Spending As A

MarketIndicator.)

In places where significant portions of the country are decimated by disasters,

governments are often left with little recourse; with a fraction of their former tax

revenue coming in and deteriorated sovereign creditworthiness, foreign aid

becomesabsolute.

Natural calamities such as the failure of rains or the coming floods may easily

cause disequilibrium in the balance of payments by adversely affecting agriculture

and industrial production in the country. The exports may decline while the

imports may go up causing a discrepancy in the country's balance of payments.

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CYCLICAL FLUCTUATIONS

Cyclical fluctuations cause cyclical disequilibrium in the balance of payments.

During depression, the incomes of the people in foreign countries fall. As a result,

the exports of these countries tend to decline which, in turn, produces

disequilibrium in the home country's balance of payment.

Business fluctuations introduced by the operations of the trade cycles may also

cause disequilibrium in the country's balance of payments. For example, if there

occurs a business recession in foreign countries, it may easily cause a fall in the

exports and exchange earning of the country concerned, resulting in a

disequilibrium in the balance of payments.

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INFLATION

In economics, inflation is a rise in the general level of prices of goods and

services in an economy over a period of time. When the general price level rises,

each unit of currency buys fewer goods and services. Consequently, inflation also

reflects an erosion in the purchasing powerof money – a loss of real value in the

internal medium of exchange and unit of account within the economy. A chief

measure of price inflation is the inflation rate, the annualized percentage change

in a general price index (normally the Consumer Price Index) over time.

Hence an increase in income and price level owing to rapid economic

developmentin developing countries, will increase imports and reduce exports

causing a deficit in balance of payments.

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PRICE COST STRUCTURE

The expenses that a firm must take into account when manufacturing

a product or providing a service. Types of cost structures include transaction

costs, sunk costs, marginal costs and fixed costs. The cost structure of the firm is

the ratio of fixed costs to variable costs.

Changes in price-cost structure of export industries affect the volume of exports

and create disequilibrium in the balance of payments. Increase in prices due to

higher wages, higher cost of raw materials, etc. reduces exports and makes the

balance of payments unfavorable.

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NEWLY INDEPENDENT COUNTRIES

The newly independent countries, in order to develop international relations, incur

huge amounts of expenditure on the establishment of embassies, missions, etc. in

other countries. This adversely affects the balance of payments position.

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INTERNATIONAL BORROWING AND LENDING

In international economics, international factor movements are movements

of labor, capital, and other factors of production between countries. International

factor movements occur in three ways: immigration/emigration, capital transfers

through international borrowing and lending, and foreign direct

investment. International factor movements also raise political and social issues

not present in trade in goods and services. Nations frequently restrict immigration,

capital flows, and foreign direct investment.

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International borrowing and lending is another reason for the disequilibrium in the

balance of payments. The borrowing country tends to have unfavourable balance

of payments, while the lending country tends to have favourable balance of

payments.

FLIGHT OF CAPITAL

Due to speculative reasons, countries may lose foreign exchange or gold stocks

People in developing countries may also shift their capital to developed countries

to safeguard against political uncertainties. These capital movements adversely

affect the balance of payments position.

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POOR MARKETING STRATEGIES

The superior marketing of the developed countries have increased their surplus.

The poor marketing facilities of the developing countries have pushed them into

huge deficits.

A marketing strategy is the backbone of any business. It generates the required

awareness about your products or services among customers. A good marketing

strategy should correlate well with the long-term marketing plans and goals of the

business.

But, due to a variety of reasons, businesses tend to go for flashy strategies or

outdated ones to market their products. This can negatively impact the sales as

well as reputation of overall business.

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CHANGES IN FOREIGN EXCHANGE RATES

In finance, an exchange rate (also known as the foreign-exchange rate, forex

rate or FX rate) between two currencies is the rate at which one currency will be

exchanged for another. It is also regarded as the value of one country’s currency

in terms of another currency

Changes in the rate of exchange are another cause of disequilibrium in the balance

of payments. An increase in the external value of money makes imports cheaper

and exports dearer; thus, imports increase and exports fall and balance of

payments become unfavourable. Similarly, a reduction in the external value of

money leads to a reduction in imports and an increase in exports.

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FALL IN EXPORT DEMAND

There has been a considerable decline in (he export demand for the primary goods

of the underdeveloped countries as a result of the large increase in the domestic

production of foodstuffs raw materials and substitutes in the rich countries.

Similarly, the advanced countries also find a fall in their export demand because

of loss of colonial markets. However, the deficit in the balance of payment due to

the fall in export demand is more persistent in the underdeveloped countries than

in the advanced countries.

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GLOBALISATION

A phenomenon of globalization of world economy consists in diminishing of the

borders between nation states. There is an important role of international trade in

this process, whose form and incentives assumes increasingly diverse forms.

While the classical theory of foreign trade basically assumed commodity trade

with the final products, currently due to fragmentation of production chains is the

dominant form of trade in intermediate goods and the trade in services becomes

more and more dynamic. Increasing volume of the trade between countries is

carried out without changing the ownership of traded goods, and vice versa -

changing the ownership of goods without crossing the border of the country.

Due to globalization there has been more liberal and open atmosphere for

international movement of goods, services and capital. Competition has beer

increased due to the globalization of international economic relations. The

emerging new global economic order has brought in certain problems for some

countries which have resulted in the balance of payments disequilibrium.

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POLICIES FOR CORRECTING BALANCE OF PAYMENTS

DISEQUILIBRIUM

1. EXPENDITURE-SWITCHING POLICIES 

These are policies that are aimed at encouraging people to switch their spending

from imported goods to domestic goods. These policies might include tariffs and

protectionism in general, manipulation of exchange rates to change the relative

prices of imports and supply-side policies aimed at improving the competitiveness

of domestic firms. In the past, countries have used marketing measures to promote

the buying of national goods and services.

2. EXPENDITURE-REDUCING POLICIES

 These are policies that aim to reduce domestic expenditure and therefore reduce

the level of imports. The main expenditure-reducing policies are deflationary

monetary and fiscal policies. These may include increasing tax, cutting

government expenditure or increasing interest rates. The impact of these policies

would be to reduce the level of aggregate demand and therefore the demand for

imports. The extent of this improvement will depend on the income elasticity of

demand for imports. The higher the income elasticity, the greater the

improvement there will be in the current account.

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3. DIRECT CONTROLS

The use of monetary or fiscal policy or of devaluation as a policy means to cure a

deficit in the balance of payments pre-supposes that there are possibilities for

income and price adjustments in the economy. A country can also use direct

controls to restore equilibrium in the balance of payments. They are usually used

to restrict imports. Then consumers will try to buy domestic goods instead of

imported goods. Hence, direct controls can be viewed as a switching policy.

Direct controls can be broadly divided into two groups that is

1. Commercial Control – To improve the balance of payments, commercial

control can be used to increase exports and discourage imports. Exports

can be encouraged by reducing or abolishing export duties, providing

export subsidy, encouraging production of export item, and export

marketing. All these may be undertaken by giving monetary, fiscal

institution and physical incentives and facilities.

2. Financial Controls- They take the form of exchange control and use of

multiple exchange rates. Under the exchange control, a government tries

to have complete control over all dealings in foreign exchange. The

recipients of foreign exchange like exporters are required to surrender

their foreign exchange to a central board bank in exchange for domestic

currency and those who need foreign exchange, like importers, have to

buy their foreign exchange from the same board or bank.

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CONCLUSION

Balance-of-payments data serve as an early indicator of whether countries are

living within their means. If current account deficits are unsustainable, it is

important that the necessary corrective actions should be taken as soon as possible

to attain high economic growth and price stability. Balance-of-payments data are

also of great significance in understanding changes in the money supply, money-

market liquidity and the exchange rate of a currency, which are all important

factors in the determination of monetary policy. In the determination of monetary

and fiscal policy, balance of payment plays an important role.

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REFERENCE

http://www.preservearticles.com/201012291895/causes-of-disequilibrium.html

http://www.investorwords.com/6462/cost_structure.html

http://goldwebtraffic.com/blog/bid/123735/How-Poor-Marketing-Strategies- Affect-a-Business

http://www.jstor.org/discover/10.2307/3484755? uid=2&uid=4&sid=21101605745911

http://kalyan-city.blogspot.com/2010/12/types-of-disequilibrium-in- countrys.html

http://kalyan-city.blogspot.com/2010/12/disequilibrium-in-balance-of- payment.html

http://en.wikipedia.org/wiki/Balance_of_payments

http://kalyan-city.blogspot.com/2010/12/concept-definition-and-structure- of.html

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