Managerial Economics -

292

2. Structure Balance of payments

Abalance of
of payment statement is a summary of a nation's total economic
It is usually composed
international trade account. account. of
transactions undertaken on (2) the capital
two sections: the current account, and
(1)
Current Account
consists of two sub-groups: (a) merchandise or the
Current account mainly
trade account and (b)invisible account.
only transactions relating to goods are
Inthe trade or merchandise account, recorded in the trade accoune
exported and imported are
entered. That is, allgoods
invisible account usually comprises the services account and the gift or
The
account. The services account records all the services rendered and received
Charities
banking and 1nsurance charges
by residents of the nation. It consists of such items as
etc. Similarly, the gifts or
interest on loans, tourist expenditure, transport charges,received or given away free
charities account consists of all those items which are
saying that
by residents of the nation. Itmay be in kind or in cash. It goes without
here that the
these are all referred to as invisible account. It is interesting to note
International Monetary Fund (IMF) includes the following items as invisible
transactions:
International transportation of goodsincluding warehousing while in transit
and other transit expenses.
Travel for reasons of business, education, health, international conventions
or pleasure.
" Insurance premiums and payments of claims.
Investment income, including interest, rents, dividends and profits.
Miscellaneous service items such as advertising,commissions, film rental,
pensions, patent fees, royalties, subscriptions to periodicals and membership
fees.

Donations, migrant remittances and legacies.

Repayment of commercial credits.
Contractual amortisation and depreciation of direct
Capital Account investment.
Capital account, on the other hand,deals with
consists of all such items as may be payments of debts and claims.
namely, private balances, assistanceemployed
by
in financing both
importsand expoa
flow,
and balances heldlon
govemment international institution agencies and spev
capital account, account.
international institutional capitalAccordingly, we shall have private
account, specie account, and
 Balanceof Paymonts
293
govermment
capital account. Balances in the
dependingiupon the accounts may rise or fall from year to
Movements or fluctuations in other items on
Items
afbalance of payments account may,thus be capital account.
Table 18.1 summarised in Table 18.1.
Balance of Payments
Current Mccount
L Merchandise--Exports and Imports: Capital Account
(a) Privae 1. Private (non-banking) loans:
b) Govemment (a) Long-tern
Non-monclary goldmovenent (b) Short-term
3 Forcigntravel 2. Banking (excluding central back)
4 Transportation 3. Official (including central bank)
Govcrnment, not included (a) Loans
(b) Amortisation
Govern1ncnt, not included elsewhere (c) Miscellaneous
Investment income
8. Miscellancous (d) Reserves (including changes in the
9. Transfer payments foreign exchange assets of the central
bank)
(a) Official
(b) Private

Total Current Transactions

Total Capital and Monetary Gold
Errors and Omissions

It should be noted that the two

accounts current, capital in the balance
eti ofpayments should necessarily balance. The surplus in the trade or current account
must be equal to the deficit in thecapital account or the
deficit in the current account.
For instance, if India's imports of goods are more than its
services to foreigners, it will have a deficit in its current balanceexports of goods and
of payment. This,
she will have to pay either in gold and other assets or by
borrowing from other
countries. These are credit items in the capital account of the balance of pay1nents.
Thus, both the current and capital accounts together will balance each other.
3. Balance of Trade and Balance of Payments
There is a marked distinction between the concepts of balance of trade and
balance of payments.
Balance of trade refers to the merchandise account of exports and imports
only. Balance of payments is abroader term and it includes balance of trade. It is
Comprethensive than the balance of trade. It includes all intermational economic
tansactions and items such as merchandise trade, services, banking, insurance,
capital flows, ,buying and selling of gold, et.
AS we know, a country may export and import many items, both visible and
invisible. Balance oof trade refers tothe visibleitems only. Import or export of goods
294 Managerial Economics -|
the countriesand
is a visible item because it is an open trade among
other hand, balance of can be easily
certified officials, On the
by the in:scope and covers thetotal debits and credits
comprehensive
customs trade is
of aall items, visiblemoreas
well as invisible. Thus,the balance of trade is only a partial study of the
balance
of
payments. It simply refers to the difference between the value of exports and visible
imports. This is what is represented in the trade or merchandise account section of
the curTent account in the balance of payments statement. Thus, balance of
nothing but a major component of the balance of payments. However.
istrade
payments includes apart from balance of trade or merchandise account,,the balance
of
account which is again composed of the services sector and gifts and inchari
visibtilees
account comprising avariety of invisible items, plus a record of capital accout
In short, balance of trade is a partial picture, while balance of payments is a
complete picture of the country's internationaleconomic relations.
Further, in the accounting sense, balance of trade may be deficit or Surplus l
may, thus, be imbalanced. But balance of payments as awhole must always balance
Forthat reason, there is an item like "Errors and Omissions" in its structure.
4. Balance of Payments AlwaysBalances
Since the balance of payments statement is drawn up in terms of debits and
credits based on a system of double-entry book-keeping, if all entries are made
correctly, the total debits must equal total credits. This is because two aspects (debits
and credits) of each transaction recorded are equal in amount and appear on the
opposite sides of the balance of payments account. In the accounting sense, balance
of payments of a country must always balance.
Inother words, debit or payment side of the balance of
a country represents the total of all the uses made of the total
payments accounts of
foreign exchange
acquired by a country during the given period, while the credit or the receipt side
represents the sources from which this foreign exchange was acquired by this country
in the same period. The two sides as such
necessarily
balance.
To illustrate the point, a simple hypothetical account of a
payments is represented in Table 18.2. country's balance of
 Balance of Payments
295
Table 18.2
Country's Balance of Payments Account
Cash (Receipts)
Deposits (Payments)
Item Rs. Item
Rs
Crores
Crores
I. Current Transactions

Merchandise Trade 8. Merchandise Trade

(Goods exportcd) 200 (Goods imported) 300
Services exported 100 9. Services imported 200
Incomefrom foreign 10. Foreign Income frorn
3 investment 200 investment at home 200
Unilateral Receipts 200 11. Unilateral pay ments 100
4

Sub-total 600 Sub-total 800

II. Capital Transactions

80
5. Long-term borrowings 200 12. Long-term lendings
13. Short-term lendings 60
Short-term borrowings 100
14. Purchase of Gold/Assets 50
Sale of Gold/Assets 100
7.
Sub-total 190
400
Sub-total
10
15. ErTors & Omission

Grand Total 1,000

1,000
Grand Total

8show the country's visible exports and imports.

InTable 18.2, rows 1 and
invisible trade. Rows 3 and 10 pertain to investment
Rows 2 and 9 refer to items of unilateral transfers like donations and gifts (private
income. Rows 4 and 11
denote
show capital movement. Rows 7 and 14
Rows 5, 6, 12and 13 enumerate receipts and
as well as official). items I to 7
gold outflow and gold inflow. Further, act of errors and omissions as a
Teveal payments.Item 15 refers
to the
the same (Rs.
show and debit sides is
ems 8 to 14
Thus, the total value of both credit
Valancing factor.
- in the
1,000 crores in our example). current and capital current
accounts or
should be noted that the two balance. Thesurplus ofthetrade in the
It
should necessarily
capital account, or the deficit In
balance of payments to the deficit in the capital account, or a defici.
account must be equal equal tothesurplus inthe delicit (-) of Rs. 200crores.
Current account must be current account shows a200 crores in the balance of
of
Our
example, the balance
corresponding surplus of Rs.
of the balance of payments
debit sides
There is, however, aresult,the credit and
Capital account. As a
e exactly balanced.
The
Balance of Payments
balanceof
nayments. Acountry whose balance of
reteredto as a
297

"surplus" payments is in
or.adverse,
deficit it is
calledcountry.
a Similarly, when its balance of surplus
'deficit' country.
is often
payments s In
The Types of
6.
The following Di sequi
are the main li brium
types of
in the
Balance of
Payments
Cyclical disequilibrium; disequilibrium in the balanceeof payments:
Structural disequilibrium;
Short-run disequilibrium; and
eLong-run or secular
disequilibrium,
cyclical Disequilibrium
t occurs on account of trade
mdecycles like prosperity.and cycles. Depending upon the different phases of
depression, demand and other forces vary, causing
anges in the terms of trade as well as growth of
deficit will result in the balance of payments. trade and accordingly a surplus or
Cyclical disequilibrium in the balance of payments may occur
because:
wirade cycles follow different paths and patterns in different
There are no identical timingsland periodicity of occurrence ofcountries.
cycles in
different countries.
.sNo identical stabilisation programmes and measures are adopted by
different countries.]
Income elasticities of demand for imports in different countries are not
identical.
Price elasticities of demand for imports differ in different countries.
In short,cyclical fluctuations cause disequilibrium in the balance of payments
because of cyclical changes in income, employment, output andprice variables.
When prices rise during prosperity and fallduring adepression country which has
ahighly elasticdemand for imports experiences adecline in the valueof imports and
Iitcontinues its exports further, it will show a surplus in the balance of paymcnts.)
Since deficit and surplus altematively take place during the depression and
POsperity phase of acycle, the balance ofpayments equilibrium is automatically set
forth over the complete cycle.
Structural Disequilibrium
in some sectors of the
emerges on account of structural changes occurring
demand or supply relations of
ecokomy
exports
at home or abroad which may alter the
or Imports or both. Suppose, the foreign demand for
India's jute produçts
employed by India in the
declines because of some substitutes,then the resources
 Managerial Economics -I
298
production of jute goods will have tobeshiftedtosome other commoditicss of export.
If this is not easily possible, India's exports may decline whereas with impors
remainingthe same, a disequilibriumin the balance of payments will arise Similarly.
expor items is changed, i.e., supply is reducedidue to crop
if the supply condition of ete
prime commodities or shortage of raw materialsor labour strikes.
failure in also exports may decline to that
extent and
the case of manufactured goods, then of payments will arise.
balance
structural disequilibrium in the
changes in tastes, fashions. habite
Moreover, a shift indemand occurs with the
to import may change as a resut)
income, economic progress, etc., propensity increase, while that for certain goods may
Demand for some imported goods may
decline leading toa structuràl change.
by variations in the rate of
Furthermore, structural changes are also producedinternational capital tends to
of
internationalcapital movements. A rise in the inflow
payments.
have a direct impact on a country's balance of
Short-run Disequilibrium
payments will bea temporary
JA short-run disequilibrium in a country's balance of country
occur once in a while. When a
one, lasting for ashort period, which may disequilibrium in its balance of
borrows or lends internationatty, it witt have short-run for a long
period þreven if they are
payments, as these loans are usually for a shortposition
duration, they are repayable later on; hence the will be automatically corrected
disequilibrium arising from international (er

and poses no serious problem. As such, a

lending and borrowing activities is perfectly justified. However,/a short-run
importsexXceed its exports in a given
disequilibrium may also emerge if a country's
once in a way, because later on, the
year. This willbe a temporary one if it occurs credit surplus
required
country willbe in a position to correct it easily by creating the disequilibrium in the
type of
by exporting more to offset the deficit.But even this long-term
balance of payments is not justified, beçause it may pave the way for a
exceeding exports or
disequilibrium. When such disequilibrium (arising from importsbecomes
period, it chronic and
even viceversa) occurs year after year over a long economic relations.
may seriously affect the country's economy and its international
reserves and the country
A persistent deficit will tend to deplete its foreign exchange
may not be able to raise any more loans from foreigners.
&9 5hoht ainall
Long-tun Disequilibrium
deficit or
The long-term disequilibrium thusrefers to a deep-rooted, persisted emerging
surplus in the balance of payments of a country. It is secular disequilibrium
deficits or
on account of the chronologically accumulated short-ter1n disequilibria
surpluses, It endangersthe exchange stabilityof the country concerned. Especially.
depleteits
a long-term defiçit in the balance of paymnents of a country tends to more
foreign exchange reserves and the Country may also not be able to raise any
Joans from foreigners during such a period of persistent deficits.
 The Balance of Payments
299
In short,true disequilibrium is a long-term
deep-rooted dynamic changes which slowly take phenomenon. It is caused by persistent
place in the economy over a long
neriod of time. It is caused by changes in dynamic forces/factors
formation, population growth, territorial expansion, technological such as capital
advancement,
innovations, etc. A newly developing economy, for instance, in its
growth needs huge investment exceeding its savings. In view of initial stages of
its low
formation, it has also to import a large amount of its capital requirementscapital
from
foreign countries and its imports thus tend to exceed its exports. These become a
chronic phenomenon. And in the absence of a sufficient inflowof foreign capital in
such countries, a secular deficit balance of payments may result.

7. Fundamental Disequilibrium
IM.E. uses the term 'fundamental disequilibrium' to describe a persistent,
long-run disequilibrium, especially, deficits which exist continuously for a long period
of time in a country's balance of payments. Unchecked series of short-run disequilibria
in a country's balance of payments ultimately lead to the 'fundamental disequilibrium'
in the long run. There are deep-rooted causes and factors in a
country's economy
which are responsible for the emergence of afundamental disequilibrium in its balance
of payments.
It is also referred to as long-term disequilibrium caused by dynamic forces and
long-term factors. A persistent disequilibrium over a long period may cause chronic
and serious disequilibrium in the balance of payments position of a
main object of microeconomic policy of a country is to correct this country.
The
disequilibrium. It is functional in nature. To correct this, various measuresfundamental
are required
to be undertaken.
The International Monetary Fund (I.M.F), however, insists that the
country facing a "fundamental disequilibrium'" in its balance of member
consult the Fund so that the Fund can advise and assist in payments should
taking some appropriate
measures like devaluation in overcoming the grave situation.
disequilibrium is to be corrected immediately if the country is to Indeed,
a long-term
economic arena. survive in the world
8. Causes of
Disequilibrium
Adisequilibrium in a country's balance of payments position may arise either
Or a short period or for a long period. Any
arise owing to alarge number of causes ordisequilibrium
factors
in the balance of payments
disequilibrium differ from country to country,operating simultaneously. Types
while the different kinds of
disequilibrium and their causes in the same country wil differ at different times.
OfHowever,! following are theimportant causes producing adisequilibrium inthe balance
payments of a
country:
in Irade Cycles. Cyclical fluctuations, their phases and
different amplitudes, differences
countries, generally produce cyclical disequilibrium.
300

2. Huge Developmental and Investment Programmes. Huge

Managerial Economics -!
andinvestiment programmes inthe developing economies are the
disequilibrium in the balance of payments of these countries.
root
Their development
causes of the.
import goes on increasing for want of capital for rapid industrialisation, propensity to
may not be boosted up to that extent as these are the primary producingwhile exports
Moreover, their exports quantum of primary commodities may decline as
created domestic industries may requirethem. Thus, there will be structural
COuntnewlrieys.
in the balance of payments and structural disequilibrium willresult.\changes
3. Changing Export Demand. Avast increase in the domestic produc tiee
foodstuffs, raw materials, substitute goods, etc. in advanced countries has decren
their need for import from the agrarian underdeveloped countries. Thus, et
demand has considerably changed, resulting in structural disequilibrium in these
countries. Similarly, advanced countries also will suffer in their exports as a result
loss of their markets in developing countries owing to the tendency of the pon
nations for self-reliance and their ways and means of curtailing their imports, But
disequilibrium (deficit) in balance of payments seems to be more persistent in the
underdeveloped or developing nations than in th¹ advanced rich nations.
4. Population Growth. High population growth in poor countries also had
adversely affected their balance of payments position. It is easy to see that an
increase in population increases the needs of these countries for imports and
decreases the capacity to export.
5. Huge External Borrowings. Another reason for a surplus or deficit in the
balance of payments arises out of international borrowing and investment. Acountry
may tend to have an adverse balance of payments when it borrows heavily from
another country, while the lending country will tend to have a favourable balance
and a deficit balance of payments.
6. Inflation. Owing to rapid economicdevelopment, the resuiting income and
price effects willadversely affect the balance of payments position of adeveloping
cOuntry. With an income, the marginal propensity to import being high in these countrics
their demand for imported articles will rise. Since marginal propensity to consume is
also high in these countries, people's demand for domestic goods also will rise, and
hence, less may be spared for export. Moreover, a huge investment in heavy industries
in the developing countries may have an inflationary impact, as the output of these
industries will not be inflationary impact, as the output of these industries will not be
forhcoming immediately, whereas money income will have been already expanded
Thus, there willbe an excess of monetary demand for goods and services in genera
which will push up the price levels. Arise in the comparative priicelevel certainly
encourages imports and discourages exports, resulting inadeficit balance of paymens
7. Demonstration Effect. Demonstration effect is another most important
factor causing deficit in the balance of payments of a country especiallycontact
ofan
underdeveloped country. When people of underdeveloped nations Come into
The Balance of Payments
301
hthose of advanced
countries through
there will be a demonstration effect on the cconomic, political or social relations,
consumption
they/will desire to have western style goods and pattern of these people and
pattern consumption so that their
of
propensity to import increases, whereas their. export quantum may remain the same
mayeven decline with thc increase in income, thus causing an adverse balance
of payments for the country.
8 Reciprocal Demands. Since intensity of reciprocal demand for products
afdifferent countries differs, terms of trade of acountry may be set di fferently with
Aifferent countries under multi-trade transactions which may lead to disequilibrium
in a way.

9. Measures for Correcting Disequilibrium

Any disequilibrium (deficit or surplus) in the balance of payments when it
persists continuously is certainly because of its disastrous effects on the country's
economy and orderly world trade. Thus, one of the basic problems of international
economic policy is restoring 'even balance' to acountry whose balance of payments
is seriously and persistently in surplus or in deficit, since both are bad for normal
intemal economic operations and intemational economic relations. Especially adeficit
or adverse balance of payments is more harmful to a country's economic growth
and has, therefore, to be corrected sooner than later. For obvious reasons, an adverse
balance ofpayments has to be corrected by encouraging exports andor discouraging
imports.
The various measures that may be used for correcting an adverse balance of
payments are of two kinds: (a) Monetary measures and (b) Non-monetary measures.
Monetary measures: () Deflation, (i) xchange Depreciation, (i) Devaluation
and (iv) Exchange control.
Non-monetary measures: () Tarifis imports duties, (ii) Import quotas, and
(ii) Export promotion policies and programmes.
Monctary measures usually have a two-edged effect in improving the balance
of payments position. They boost up exports as well as check or curtail imports.
Monetary measures, however, function indirectly. Non-monetary measures, on the
other hand, are directly effective. But they work one way only Tarifis and quotas,
tor instance, tend to restrict only imports. Export promotion measures, on
the other
hand,enhance exports only.
10. Deflation
Basically, a deficit in the balance of payments occurs due to high imports and
OW exports. This is to be reversed. In this regard,
that the traditionally, it has becen suggested
rate and country may adopt deflationary dear money policy by raising the bank
or
restricting credit. Under deflation, prices of domestic goods fall which
makes Cxports attractive and immports relatively costlier:
302 ManagerialEconomics -l|
Under deflationary policy, thus, the export items of the country in the forcign
market become relatively cheaper and the demand for them will rise so that exports
will increase. Moreover, deflation attempts to restrict home consumption through
reduction of incomes; demand for goods at home will be reduced and more surplus
may be increased. With a
may become available for export purposes so that exports
import willalso decline and
fall in domesticincome of the people, their propensity to importsdecline as a result
imports will becurtailed. Thus,when export increase and
of an impact of deflationary monetary policy, a
deficit in the balance of payments
gets automatically corrected.
tries tocorrect the deficit in
Deflation keeps exchange rates unaffected and
the balance of payments through domestic changes.
countries are on a gold starndard
However, deflation is fruitfully employed when rates
work ability assumes that exchange
or on fixed exchange rates, because its
are unchanged during its course.
Secondly, the appropriate extent of deflationary policy to be followed in correcting
determinedin relation to the degrees of elasticity
a deficit balance of payments is to be deflation would be just enough to boost
of demand for imports and exports. A mild
and curtail imports, when the elasticities of demand for imports and exports
exports
greater than unity. Then, there is no problem. But a severe deflation is inexpedient.
are and exports are less than unity, a
And when the elasticities of demand for importsharm the employment and income
severe deflation will be necessitated which will
levels of the country.
dangerous to a poor
Inshort, deflation being inexpedient, its side effects aredeveloping economy
a
country. It creates more unemployment and poverty. Again,monetary policy to cater
contractionary
has to adopt an expansionary rather than a
to developmentalneeds.
11. Exchange Depreciation
payments is to
Another important method of correcting an adverse balance of obviously
depreciate the external (exchange) value of the home currency. Thisdevice exchange
assumes that the country has adopted aflexible exchange rate policy Thus,
depreciation is feasible. By exchange depreciation is meant a decline in the rate of
exchange of one country in terms of another's. Suppose the rate of exchange between
adverse
the Indian Rupee and U.S.Dollar is: $1 = Rs. 10. If India experiences an
American
balance of payments with regard to America, the Indian demand for
of the
currency, i.e., dollar, will rise. Consequently, the price of the dollar in terms
itS
rupee will appreciate in its external value, while the rupee will depreciate in
external value. Thus, the new rate of exchange may become, say: $1 = Rs. 12
which implies 20 per cent exchange depreciation of the Indian currency.
Exchange depreciation of a country will tend to cheapen its domestic goods
for he foreigners so that its exports will be boosted, while its imports will be costliel
 The
Balance of Payments
303
they willtend to declineJThus,
a fall in exchange rate imports
that
will be
or the external checked
so
simulatedby and exports will be
country/The country may thus achieve a value of the currency of a
deficit
favourable balance to pay off an earlier
Ifthecountry'sodemandfor imports and exports is
depreciation willtend to correct a normal fairly elastic, asmall exchange
deficit inthe balance of payments.
afree
trade policy, its operation is automatic. However, a very Under
depreciation will be neededto contain the situation if the large exchange
exports inelastic. Further, the success of this
is demand for imports and
method
the foreigners who shoulddepends
the co-operation of to a very large
extent upon be
themselves to such a policy. Otherwise, if all prepared to adjust
countries start
exchangerates,,then the technique may not prove usefulto any depreciating their
e the depression period in the thirties. country as it happened
Moreover, the device of exchange
depreciation does not suit a country desiring a fixed
circumstances. It will also increase the uncertainty and exchange rate in any
risks involved in foreign
rade. which will hamper its growth. Furthermore, exchange depreciation causes
Px
high prices of imports and low prices of exports, so that the terms of trade will
Pm
move unfavourably for the country resorting to this device.
Exchange depreciation is automatic and can easily correct a mild adverse
balance of payments if the country's demand for imports and its foreign demand for
exports are fairly elastic. However, the success of this method depends to a very
large extent upon the co-operation of foreigners who should be prepared to adjust
themselves tosuch apolicy. Otherwise, if the foreign countries also start depreciating
their exchange rates, then the techniques may not prove useful to any country as
had happened during the Great Depression of the thirties. Moreover, the device of
exchange depreciation does not suit acountry desiring afixed exchange rate in any
Cicumstances. Furthermore, experience of certain countries indicates that exchange
depreciation may result in an inflationary spiral, as it may be followed by an increase
mnoney incomes and a rise in domestic price levels.
However, this method is not feasible under the present system of IMF which
prescribes a fixed exchange rate system.
12. Devaluation
Amost commonly adopted method consists in devaluation of the currency of a
unry Taced with an adverse balance of payments.
15 an alternative to exchange depreciation. It is suitable under the present
in Fsystem. Devaluation means official decrease in the external value of acurrency
tTupeeGoevremmsmeofntforeign
Currency or good pr SD Rs. Suppose 1$= Rs. 8and if the Indian
puts it as 1$ = Rs. 10,i meansa 25 per cent devaluation of the Indian
in I terms of the
U.S.dollar.
 Managerial Economics - I|I
304

Essentially, devaluation is nothing but making de facto exchange depreciation

depreciation is based on the market mechanism whereas
de jure. Exchange Devaluation is undertaken when the currency is found to be
devaluation is arbitrary.
unduly overvalued
impact would be relative cheapness
When a country'scurrency is devalued, the
the foreigners and relative dearness of its imports. Consequently.
of its exports to
imports decline. This will help removal of the deficits in the
exports willrise and
balance of payments.
resort to devaluation of its currency
In modem times, generally a country
fundamental disequilibrium (deficit) in its
when it intends to corect achronic and cause of its adverse balance of payments,
balance of its currency which is the root
currency. A country's currency may
acountry has no alternative but to devalue its
be overvalued in terms of a foreign currency
(thanks to persistent inflation) and
currency is cheap and
therefore, at the present official exchange rate the foreign exports,
and lesser
commodities are also cheap, resulting ultimately in larger importsdepreciation
facto of the
causing an adverse balance of payments and ultimately deDevaluation will then be
external value of the currency in the exchange market.
necessitated. In short, acountry adopts devaluation as an export promotion device
When
and import curbing measure for correcting its adverse balance' of payments.
a country lowers its exchange rate, foreigners will find it beneficial to buy more
from this country, so that its exports willbe a contraction of imports which tend to
produce a favourable balance of payments for the country.
Conditions for the Successful Working of Devaluation
The success of devaluation, however, depends on certain conditions:
1.A fairly elastic demand. Afairly elastic demand for imports and exports
will ease the way for the successful functioning of devaluation to achieve its desired
goal. But if the country's demand for imports and exports is inelastic, devaluation
willworsen the balance of payments position by increasing the total value of imports
while, at the same time, reducing the total value of exports.
It has been generally contended that devaluation will improve the
balance of
payments of the country if the sum of elasticities of its demand for imports and
exports is greater than unity, i.e., (Dm + Dx> 1). If this sum is less than unity
+ Dx< l), the balance of payments (Dm
position will become worse by devaluation.
2. Structure of Imports and
Exports. If the devaluing country's exports
consist of non-traditional items, and have a large
itcan gain by improving its terms of trade due to demand from the rest of the world,
increase in world's demand for its
products induced by devaluation. But, if its exports are
and imports are of manufactured largely of primary products
goods and
always have unfavourable terms of trade; so itindustrial raw materials, etc., it will
will lose more under
devaluation.
 Balanceof Payments 305
The
3. Domestic Price Stability. Maintenance of internal purchasing power of a
devaluingcountryis very essential to realisethefruitful effects of devaluation. Success
ofdevaluation requires that when the external value ofa currency is deliberately
rduced,theinternal value of the currency should not change, otherwisethe whole
puposewillbe defeated. In other words, the cost-price structure of the devaluing
should not alter. There should be no inflation.
country.
However, the cost-price structure of acountry may change and an inflationary
impact maysetin by devaluation inthe following circumstances:
a) When imports of certain goods are curbed but their domestic output is not
increased, scarcity of such goods will be felt which may cause a rise in
prices of such goods.
(b) As an impact of devaluation, if exports increase without an adequate
expansion of export industries, the supply of domestic market will decrease
so that prices of such goods may rise, if demand pressure in the domestic
economy tends to remain the same.
(c) When the devaluing country is capital-deficient, it continues to import
necessary capitalgoods and certain import components even at a high
cost, as a result of which prices of its industrial output may rise.
(d) When owing to a rise in the prices of a large number of goods, the cost of
living tends to rise, higher wages may be demanded by labour so that cost
push inflation may gather further momentum.
Under such inflationary bias in the cost-price structure induced by devaluation,
its efficacy is certainly undermined to a great extent. However, if a tight nonetary
and fiscal policy is followed with devaluation, its inflationary impact is minimised.
4. International Co-operation. Devaluation will serve its purpose only if
other countries do not retaliate by resorting to simultaneous devaluation. The rest of
the world must be prepared toco-operate fully with the country devaluing its currency
d by not raising import duties or giving export bounties or devaluating its currency
which may also tend to nullify the beneficial effects of devaluation enjoyed by the
cOuntry under consideration.
5. Co-ordination ofother measures. If the act of devaluation is co-ordinated
with ahike in import duties, lowering of export duties, liberalisation of export licences,
King of import quotas, export promotion programme etc., devaluation will prove to
be more effective. If., however, other measures are contrarily adopted, the desirable
effects of devaluation will be adversely affected.
Drawbacks of Devaluation
The following are the major drawbacks of devaluation:
1. Devaluation is the acknowledgment of a country's economic weakness.
2. It may induce inflationary tendencies in the domesticeconomy.
 306
Managerlal Economics -||
3. It inflates the burden of debt servicing.
effects.
4. It involves a considerable time lag increating its
5. Its effect is general anddrastic.
Concluding Remarks
Though devaluation combines the advantages of both exchange depreciation
and stable exchange rates, the device is not always successful in helping a country
face an adverse balance of payments if other factors are operating unfavourably
Since the success of devaluation depends upon so many factors, a country must
examine them carefully before resorting to this device. It also has inherent
drawbacks.

13. Exchange Control

Restrictions on the use of foreign exchange by the central bank are called
"exchange controls." When an exchange control is
to surrender their foreign exchange earnings to the adopted, allthe exporters have
control, the central bank releases foreign exchanges central bank. Under exchange
only for essential imports and
conserves the rest of the balance. This is the most direct method of curbing imports.
In general, however, exchange
control
disequilibrium by suppressing the deficit whichdeals with the balance of payments
trouble. Exchange controls deal with only the is only a symptom and not the basic
accentuate those causes tending to create a more deficit, not its causes, and they may
Words, an exchange control can prevent a basic disequilibrium. In other
the condition of complete breakdown, but it cannot eliminate
to the problem ofdisequilibrium. Thus, an exchange control offers no permanent solution
persistent
temporary measure, to gain time disequilibrium. It can, at best, be
while other more justified only as a
made to restore equilibrium in the balance of payments.fundamental adjustments are
14. Non-Monetary Measures
Apart from the monetary
important measures for balancingmcasures, non-monetary
the balance measures are also equally
of payments, in a functional sense.
Tariff, import quotas and export
problem of deficits in the country's promotion are very useful in dealing with the
balance of payments.
Tariff (Import Duties)
Tariff is a fiscal device which may be used tor
balance of payments position. correcting an unfavourable
A schedule of duties levied upon the importation of
commodities into a giyen
nation from abroad is called atariff. I refers to custom duties levied on imorte
 Payments 307
The Balance of
Acountry having atariff
a deficit balance of payments position canrestore and maintain
equilibrium by means of frestrictions uponimports.
Imposition of import duties willraise the pricesof imported goods.This may
lead to a
contraction of demand forimports. Check on imports helps inimproving
of payments.
the position of the balance
Drawbacks of Tariff
however, criticised
Tariff as a means of correcting disequilibrium has been,
severely as follows:
trade.
1. Itbrings equilibrium through a contraction of foreign
and
2. It thus inhibits the advantages of large and expanding world trade
prosperity.
3. It adjusts the equilibrium without mitigating the root causes of disequilibrium.
4. Sometimes, the imposition of new or higher tariffs may aggregate a
disequilibrium in the case of a country already experiencing a surplus in its
balance of payments. In such a case, new or higher tariffs will tend to
intensify the existing maladjustments in the balance of payments.
5. Since the imposition of tariff duties does not necessarily imply a reduction
in the value of imports, the effect of a tariff on the balance of payments
cannot be very certain.
Import Quotas
Fixing of imports quotas is another and perhaps a better device used for
correcting an adverse balance of payments. Under the quota system, the government
may fix and permit the maximum quantity or value of a commodity to be imported
during agiven period. By restricting imports through the quota system, deficit is
reduced or eliminated and thereby the balance of payments position is improved.
Asa direct method of correcting disequilibrium in the balance of pay ments,
Import quotas are assumed to be better than import duties. Quotas have the immediate
effect of restricting imports as the marginal propensity to import becomes zero once
the
quota limit is reached. Thus, the effect of quotas on quantitative restriction of
mports is explicit. But the balance of payments effects of import duties are not so
certain.
laritfs will not be very effective in reducing imports when the demand for
nports is inelastic. Further, tariffs are rigid and less flexible as tarift is budgetary
phenomenon, subject to a parliamentary control. Quotas, on the other hand, can be
more easily changed without resorting tolegislation. Quotasystem, particularly, the
bilateral quota is more suitable for the negotiation of trade concessions and mutual
agreement
such as theys bring revenue
with other nations. But in other respects, tariffs have their own merits,
to the state and preserve competitive market conditions
 308 Managerial Economics -|
as against quotas which bring no revenue and| brecd monopolistic position
importers. Besidcs,the distribution of quotas may involve
comiption and. among
A prudent government thus adopts both
the mcasures
simultaneouslyditoscrachi
imineatveion.its
goal.
Export Promotion
To corect disequilibriumin theetbalance of payments, iit is necessary that
should be increased. Govenmentmay adopt exportpromotion programmes exports for
purpose. An export promotion progmame includes subsidies, tax concessione
exporters, marketing facilities, incentives for exports, loan priorities to the
sector under the credit policy of the central bank, etc. export
'Export or perish' should be the slogan for any country facing the problem of
fundamental disequilibrium in its balance ofpayments.
Import Substitution
To check the import needs and thereby to reduce the quantum of imports, a
deficit country may alsoresort to import substitution. Thus, industries producing
import substitutes may be induced and encouraged by the state to be more self
sufficient and less reliant on imports.
Concluding Remarks
All these non-monetary measures are, however, considered more effective.
significant and are normally applicable than monetary measures in correcting the
adverse balanceof payments. Fixing of import quotas and tariffs to check imports
and launching upon export promotion programmes is perhaps the best solution to
correct the disequilibrium in the balance of payments. Devaluation of currency may
be resortedto only under abnormal conditions.
1. TRENDS IN INDIA'S BALANCE OF PAYMENTS
Balance of payments is a systematic record of official estimates of all
international economictransactions of the country during a year. It is an economic
parameter rejecting country's international financial position as wellas its position of
the external sector. In more specific terms, the Reserve Bank of India defines the
balance of payments of a country as a systematic record of all economic transactions
between the 'residents' ofa country and the rest of the world. It presents a classitiea
record of all receipts on account of goods exported, services rendered and capital
received by 'residents' and payments made by them on account of goods imported
and services received from the capitaltransferred to 'non-residents' or 'foreigners.
In economic analysis, the term Balance of Payments (BoP) is a very useful
and meaningful concept. The concept of BoP is used in two sense: simple a
analytical. Ina simple or narrow sense, the term of balance of payments is used to
the systemsof accounts relating toa country's international economic transactions.