Page 139 - DECO503_INTERNATIONAL_TRADE_AND_FINANCE_ENGLISH

Unit 11 : Balance of Payments and Balance of Trade : Meaning and Components

Boardly, certain BOP principles can be laid down with global perspectives in mind (a) current and Notes
capital accounts with similar signs are both undesirable; they tend to aggravate problems of
international liquidity and hamper growth of world trade, (b) the correct behaviour for a country
with a surplus on current account is to lend abroad and run deficits on capital account.
The second aspect of BOP deficit or surplus is its duration. If the deficit in the BOP, regardless of its
location, is of a temporary nature, say on account of export crop failure, or political events which
might have led to temporary capital flight, then such a transient effect on the BOP may not be a cause
of serious concern. If the BOP deficit is fundamental or persistent, especially arising out of current
disequilibrium, such a prolonged deficit is bad. It is suggestive of some structural disequilibrium
which calls for corrective action. Current account deficits of short term duration can be handled by
short term or long term foreign borrowings. But the current account deficits which are repeated year
after year cannot and should not be financed by foreign borrowings alone. In the final analysis,
exports have to pay for imports and it would be necessary to reverse the current account surpluses,
like persistent current account deficits, need to be given close scrutiny, because over the years they
increase foreign indebtedness and make the country’s BOP situation extremely vulnerable. In short,
if the deficits or surpluses in current or capital account are of a temporary nature, they do not constitute
a problem; but if they become persistent, they need corrective policy action.
Now let us come to the normative judgement issues on ‘deficit’ and ‘surplus’ questions in current
account. Generally it is believed that current account deficits are bad and surpluses are good. It is
easy to see how deficits in current account are bad, especially when the deficits are prolonged and
lingering. What about current account surpluses ? Are they unquestioningly good for a country ?
Here again one may readily agree that occasional or temporary surpluses are good, and especially
so, if these surpluses are essential (a) to offset capital account deficits or (b) to offset investment
income outflows or to pay off old debts. If, on the other hand, a country is running persistent surpluses
in its current account, not offset by capital account deficits, it will run several risks : (a) accumulation
of foreign (official) reserves by the country’s monetary authority; which leads to expansion in money
supply and domestic inflationary price upsurge or (b) exchange rate appreciation which would in
turn make the country’s exports less competitive in the world market; which leads to import expansion
and export contraction. The precise nature of the result depends of course on the country’s exchange
rate policy, monetary and fiscal policy and exchange controls policy. In any case, persistent surpluses
in the BOP do not necessarily produce healthy effects on the economy. It is necessary to realize that if
BOP deficits are not good, so is the case with BOP surpluses. BOP ‘disequilibrium’ denoting as it
does, something undesirable, applies equally to ‘deficits’ and ‘surpluses’ alike, although deficits pose
a more serious threat and a more difficult challenge than the BOP surpluses.
Balance of Payments Settlement and Adjustment

A distinction is made between BOP settlement and BOP adjustment and this distinction can be
understood if we proceed as follows. Suppose, we have a deficit (or a surplus) in the current and
capital accounts of our country’s BOP, then we can “settle” this deficit (or surplus) arising out of
imbalance in the autonomous transactions by accommodating payments (or accommodating receipts
in case of a surplus) so as to produce a BOP balance in the accounting sense. In this case, therefore,
what we have undertaken, is a process of BOP settlement. We have, in this case, merely and temporarily
overcome the BOP problem with the help of necessary accommodating transactions. The fire, so to
speak, has been extinguished but the house is still not reconstructed. If, on the other hand, we control
the deficit (or surplus) by controlling the forces which were causing this deficit (or surplus) then we
have undertaken what may be called as BOP adjustment. BOP adjustment is said to have taken place
only when we have produced ‘balance’ in autonomous transactions i.e. when autonomous credit
receipts are equal to autonomous debit payments. In brief, when accounting balance is produced
with the help of accommodating transactions there is said to be BOP settlement; and when this balance
is produced without the help of accommodating transactions, there is said to be BOP adjustment.
Adjustment is more desirable and more difficult than settlement.

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