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Methods of Correcting Disequilibrium in Balance of Payments of a Country

Updated on June 1, 2014

Meaning of Balance of Trade

The balance of trade of a country is the difference between the value of its exports over a period, and the value of its imports. If, in a given period, the value of its exports is greater than the value of its imports, the country is said to have a favorable balance of trade. If, on the other hand, the value of its imports is greater than the value of its exports, the country is said to have an unfavorable balance of trade. In the past, the emphasis was always on a favorable balance of trade because that meant a great flow of gold or some other form of money into the country and in those days they identified gold and other precious metals with the real wealth of the country. In balance of trade, we take into account only the commodities that enter into transaction. In other words, we take into account the import and export of commodities. We include only ‘visible items.’

Meaning of Balance of Payments

The balance of payments of a country is a record of its monetary transactions, over a period, with the rest of the world. It includes besides the balance of trade, certain other items and payments known collectively as ‘invisible items.’ While considering ‘balance of trade’, we take into account only visible items, that is, import and export of goods. But balance of payments includes visible as well as invisible items. “Balance of payments” is also called “Balance of accounts.”

On the side of imports, ‘invisible items’ include some of the following important items.

  1. A country may have to pay for the shipping services and other services rendered by other countries.
  2. When the citizens of a country spend money while travelling abroad for pleasure or on business, technically speaking, it is like importing goods from abroad.
  3. A country may have to pay dividends to foreign investors.
  4. A country may have to repay loans borrowed in the past or may have to pay interest on the loans.

On the side of exports, ‘invisible items’ include such items and services for which a country receives payments. The main items are:

  1. The payments to the country for the banking, shipping and insurance services rendered to other nations.
  2. Income from foreign investments
  3. Money spent in the country by foreign tourists
  4. Interest on loans given abroad or repayment of loans by other countries. It should be remembered that these are not the only items for which a country receives payments. A country receives payments for many other items.

When one wants to know something about the economic position and performance of a nation, one should take into account its balance of payments position and not its balance of trade. Of course, a continuously unfavorable balance of trade over a long period may result in unfavorable balance of payments position. A country will have deficit balance of payments when the value of its imports (both visible and invisible items) is greater than the value of its exports. Deficit balance of payments position does not always mean that a country is in a financially weak position.

Methods of Correcting Disequilibrium in Balance of Payments

A continuous deficit in balance of payments will have to be corrected eventually. There are many methods for correcting the disequilibrium. Some important methods are discussed below.

  1. Imports can be restricted. This may be done by fixing import quotas and in some cases by prohibiting the import of some non-essential commodities. However, a disadvantage of this method is that people may be denied some important foreign goods and sometimes it may affect the supply of raw materials greatly needed for industry.
  2. Measures can be taken to stimulate exports. This can be done by developing industries in the export sector. Government can provide both financial and non-financial assistance to them. Increased exports will earn foreign exchange to make up the deficit.
  3. A country, which is in balance of payments deficit, can borrow from other countries. It can borrow from some friendly countries or from international institutions like the International Monetary Fund. But this method will solve the problem only for the time being. It is not a permanent solution.
  4. It may be possible to get aid by way of outright gift from some other country. The U.S.A. helped many countries in Europe after World War II by giving them outright gifts. Even today, most of the underdeveloped nations receive such gifts from the rich countries of the world. An advantage of the method is that there is no problem of repayment. But the disadvantage is that ‘gifts’ may not come in large quantities and there is the element of uncertainty.
  5. Devaluation of the currency is another method. This will stimulate exports. However, if other nations also play the same trick, it may result in bad consequences.

© 2013 Sundaram Ponnusamy

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