Here is a clear and complete explanation of how the Balance of Payments (BoP) develops in international trade situations, along with the causes of disequilibrium and the measures to correct it:
20/June/2025 00:42
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How Balance of Payment Develops in International Trade
The Balance of Payment (BoP) reflects a country’s economic transactions with the rest of the world, mainly through international trade.
Development in Trade Situations:
1. When Exports = Imports
The BoP is said to be in equilibrium.
This means a country earns as much foreign currency as it spends.
2. When Exports > Imports
The country has a BoP surplus.
It receives more foreign currency (credit) than it pays (debit).
3. When Imports > Exports
The country faces a BoP deficit or disequilibrium.
Outflow of currency exceeds inflow, which may lead to borrowing or currency depreciation.
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Causes of Disequilibrium in Balance of Payment
1. Trade Imbalance
Excessive imports and low exports cause a trade deficit.
Can occur due to domestic shortage, changing consumer preferences, or low competitiveness.
2. High Inflation Rate
Increases domestic prices, making exports costlier and imports cheaper.
Reduces export earnings and increases import bills.
3. Overvaluation of Currency
Makes domestic goods expensive for foreign buyers and foreign goods cheaper for locals.
Hurts exports and encourages imports.
4. Poor Industrial Productivity
Low production levels lead to import dependence and weak export capacity.
5. Political Instability
Reduces foreign investment and damages trade relationships.
Leads to capital flight and lower inflow of foreign exchange.
6. High External Debt
Repayment of interest and principal causes outflow of foreign currency.
7. Lack of Foreign Investment
Lower capital inflow through FDI or FII causes shortage of foreign reserves.
8. Change in Global Demand
If global demand shifts away from a country’s exports (e.g., oil, textiles), it causes export decline.
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Major Measures to Correct Disequilibrium in BoP
1. Export Promotion
Provide subsidies, tax benefits, or incentives to boost exports.
Improve product quality and competitiveness in global markets.
2. Import Substitution
Encourage domestic production of goods that are heavily imported.
Protect domestic industries through tariffs and quotas.
3. Devaluation of Currency
Reduce the value of the domestic currency to make exports cheaper and imports costlier.
Increases foreign demand for local products.
4. Foreign Exchange Control
Regulate the use of foreign currency for imports and investments.
Prevents unnecessary outflow of foreign exchange.
5. Attract Foreign Investment
Create policies to attract FDI and FII, increasing foreign currency inflow.
6. Monetary and Fiscal Measures
Control inflation through interest rate adjustments and reduced government spending.
Helps stabilize the economy and promote exports.
7. International Borrowing
Temporary solution where the country takes loans from IMF or World Bank to manage BoP deficits.
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Conclusion
A country’s Balance of Payment develops based on the flow of trade and capital across borders. When there’s a mismatch between inflows and outflows, disequilibrium occurs, which can threaten economic stability. Understanding the causes and corrective measures is essential for policymakers to maintain a healthy and stable international financial position.
