Balance of Payments

Disequilibrium- Causes,
Consequences and Solutions
CAUSES AND CONSEQUENCES OF
BALANCE OF PAYMENTS-
DISEQUILIBRIA
? What is Balance of Payments Disequilibria?
? Which account on the Balance of Payments account is most likely to have a diseqilibrium
and why?
Balance of Payments Disequilibria

? The balance of payments account is made to balance. However in practice, there will be
surpluses and deficits in different parts of the account (either in the capital or current
account). A deficit or surplus indicate disequilibrium in the BOP

? In other words, a country’s BOP is said to be in disequilibrium when its receipts/

inflows/credits is NOT equal to its payments/outflows/debits
? Deficit occurs when the value of debit items exceeds the value of credit items. This is
viewed as unfavourable

? Surplus occurs when the values of credit items exceeds the value of debit items
? 3) POLITICAL FACTORS- Political factors includes political instability in a country,
war, changes in diplomatic policy cause a lack of confidence in an economy and
uncertainty among foreign investors. Political instability and disturbances cause large
capital outflows and hinder Inflows of foreign capital.
CONSEQUENCES OF DISEQUILIBRIUM

? What some consequences of Disequilibrium?

Consequences of Balance of Payments
Disequilibria
? Trinidad and Tobago has experienced BOP disequilibrium (deficit) for 5 consecutive years.
What impact will this have on the following:
1)Foreign investors
2) Consumers
3) Government
4) Import prices
5) Standard of living of citizens
6) Export prices
Consequences of Balance of Payments
Disequilibria
? 1) Reduction in foreign investment because of risks involved
? 2) Restriction to consumers for goods not produced locally. Imports are also
likely to have a higher rate of tax to restrict consumption
? 3) Pressure on government to introduce protection measures
? 4) Import prices will rise, increasing the cost of living and causing cost-push inflation
? Export prices will fall
Balance of Payments Deficit

? If there is a deficit, this means that outflows exceeds inflows or payments made by a
country are greater than payments received by the country. This can be settled by drawing
on reserves, obtaining loans or selling foreign assets. However, if deficits persists debts
will increase and reserves will be used up. Other action must therefore be taken.
Causes of balance of payments deficits

? Most countries have deficits in the current account, mainly because imports exceed exports.
The following are some causes of balance of payments deficits:
• Increasing demand/ purchase of imported gods and services ( outflows exceed inflows)
• Investment income being paid out to foreigners being greater than investment income
coming into the country. (outflows exceed inflows)
• Overvalued local currency (outflows exceed inflows)
• Decrease in visitors ( lack of inflows)
• Investment being made abroad by domestic residents is greater than foreigner investors in
domestic economy (outflows exceed outflows)
• Transfers by government and individuals greater than transfers coming in (outflows
exceed inflows)
 Consequences of balance of payment deficit

•Increase in unemployment- If local residents are demanding more imports, local firms will
be affected leading to increased unemployment

•Fall in Foreign Exchange reserves- If outflows are greater than inflows, to finance the
deficit reserves will need to be drawn upon

•Exchange rate depreciation- A deficit means that more foreign currency is being used for
imports which leads to a depreciation of the local currency
Balance of Payments Surplus

? If there is a surplus, this means that inflows exceed outflows or payments received by a
country are greater than payments made by the country.

? If a country has a surplus this means that its trade partners have deficits and may be unable
to purchase goods from your country in the future leading to a potential fall in export
earnings.
Causes of balance of payments Surplus

•Decreasing demand/ purchase of imported gods and services and increasing demand by foreigners for
locally produced goods and services (inflows exceed outflows)

• Investment income paid into the country being greater than those being paid out to foreigners
(inflows exceed outflows)

•Greater investment in the local economy by foreigners than foreign investment made by domestic
residents abroad (inflows exceed outflows)

•Transfers in the country greater than transfers out of the country (inflows exceed outflows)
Consequences of balance of payment surplus

•Decrease in unemployment- As locals demand more locally produced goods and services,
local firms expand production and so employ more labour

•Increase in Foreign Exchange reserves- A surplus adds to foreign exchange reserves

•Exchange rate appreciation- Increasing demand for local currency leads to an appreciation
of the local currency

• Inflation- Increased demand for local goods lead to inflation

MEASURES TO REDUCE A BOP DEFICIT

? What does a BOP deficit means?

? What happens to the official reserves as a result of a deficit?
MEASURES TO REDUCE A BOP DEFICIT

? Any policy to reduce a BOP deficit has to reduce outflows or increase inflows
1) Contractionary/Deflationary Monetary and fiscal policy
2) Import controls such as embargos, quotas, tariffs
3) Devaluation – (deliberate downward adjustment on the value of a country’s currency) of
currency makes goods cheaper to export and more expensive to import leading to a
reduction in the deficit
MEASURES TO REDUCE A BOP SURPLUS

? Any policy to reduce a BOP surplus has to increase outflows or decrease outflows
1) Increasing Aggregate demand through Expansionary/Reflationary Monetary and Fiscal
Policy
2) Reduction of import controls
3) Revaluation of currency (rise in value of a country’s currency)
Assignment

? 2021 5e iii
? 2016 4 d
? 2013 6d
? 2012 3d