What measures can be adopted to correct a balance of payments deficit? | TutorChase (2024)

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What measures can be adopted to correct a balance of payments deficit? | TutorChase? ›

To correct a balance of payments deficit , a country can devalue its currency, increase exports, reduce imports, or implement fiscal austerity. Devaluing the currency can make a country's exports cheaper and imports more expensive, thereby improving the balance of payments.

Promotion of export is the best measure to correct an adverse balance of payments. For this all taxes on export goods be withdrawn, export industries should be provided new materials and transport facilities at reduced prices, so that prices of these goods remain low.

A trade deficit occurs when a country import more than it exports, which is also known as the negative balance of trade. One way of correcting trade deficit is by the devaluation of a home currency. This is an official lowering of the value of a country's currency within a fixed exchange rate system.

The disequilibrium can be corrected using policies like currency devaluation, trade policy measures, exchange control and demand management. These policies aim at promoting exports, reducing imports and controlling foreign capital flows. However, these policies also have their costs and limitations.

Devaluation Strategy

As exports increase and imports decrease, there is typically a better balance of payments as the trade deficit shrinks. A country that devalues its currency can reduce its deficit because of the greater demand for its less expensive exports.

Causes of BoP Deficit

High outflow of foreign exchange to meet import demands like technology, machines, and equipment can lead to BoP deficit. Sustained rise in a country's prices can often make foreign products cheaper, leading to a high volume of imports. Unstable tax structures, change in government, etc.

The balance of payments, or balance of international payments, is an accounting statement of the economic transactions that have taken place between the residents of one country (including its government) and the residents of other countries during a specified time, usually a year or a quarter.

Countries can shift from a trade deficit to a surplus by investing heavily in export-oriented manufacturing or extracting industries. It is also possible to move toward a trade surplus by placing tariffs on imported goods, or by devaluing the country's currency.

A stronger exchange rate, of course, makes it more difficult for exporters to sell their goods abroad while making imports cheaper, so a trade deficit (or a reduced trade surplus) results. Thus, a budget deficit can easily result in an inflow of foreign financial capital, a stronger exchange rate, and a trade deficit.

A trade deficit is neither inherently entirely good or bad, although very large deficits can negatively impact the economy. A trade deficit can be a sign of a strong economy and, under certain conditions, can lead to stronger economic growth for the deficit-running country in the future.

What are the two types of disequilibrium in BoP? ›

Double-entry bookkeeping Principle: The balance of payments account of a country is constructed on the principle of double-entry bookkeeping. Each transaction is entered on the credit and debit side of the balance sheet. Thus, the total debit and the total credit of the balance of payments are always equal.

The BoP consists of three main components—current account, capital account, and financial account.

What is Balance of Payments Deficit? A balance of payments deficit means the nation imports more commodities, capital and services than it exports. It must take from other nations to pay for their imports.

Importance of Balance of Payment

It examines the transaction of all the exports and imports of goods and services for a given period. It helps the government to analyse the potential of a particular industry export growth and formulate policy to support that growth.

It measures the flow of funds between a nation and the rest of the world for the purchase of goods and services and income transfers. It includes the visible (goods) and the invisible (services) balance, and is simply referred to the balance of trade.

IB Economics Tutor Summary: The balance of payments is always balanced due to it being a double-entry system, where every economic transaction with the world is recorded twice: as money coming in and going out. It comprises two main parts: the current account and the capital and financial account.

7- Balance of Payments (Edexcel A-Level Economics Teaching PowerPoint) In economics, the balance of payments (BoP) is a comprehensive accounting framework that records all economic transactions between a country and the rest of the world over a specified period, typically a year or a quarter.

The absorption approach to the balance of payments states that a country's balance of trade will only improve if the country's output of goods and services increases by more than its absorption, where the term 'absorption' means expenditure by domestic residents on goods and services.