Question

What are the reasons of disequilibrium in Balance of Payments ?

Hint:

A "Deficit" in BOP is more concerning for an economy than a "Surplus."
Persistent deficits can lead to currency depreciation and depletion of foreign exchange reserves.

Answer 1

Step 1: Understanding the Concept:
Balance of Payments (BOP) is a systematic record of all economic transactions between residents of a country and the rest of the world.
Disequilibrium refers to a situation where the credits (receipts) do not equal debits (payments), leading to either a surplus or, more commonly, a deficit.
Step 2: Detailed Explanation:
The reasons for disequilibrium can be categorized as follows:
1. Economic Factors:
- Developmental Expenditure: Developing nations often import heavy machinery and technology, leading to a deficit.
- Inflation: High domestic prices make exports expensive and imports cheaper, worsening the trade balance.
- Cyclical Fluctuations: Recession in foreign markets reduces demand for exports.
2. Political Factors:
- Political Instability: Frequent changes in government or civil unrest discourage foreign investment and disrupt trade.
- Diplomatic Relations: Trade barriers or sanctions imposed due to political conflicts lead to BOP issues.
3. Social Factors:
- Change in Tastes and Preferences: A sudden preference for foreign goods increases imports.
- Population Growth: Rapidly rising population increases domestic demand for goods, leaving less for export and requiring more imports.
- Demonstration Effect: People in developing countries imitating the consumption patterns of developed nations lead to higher luxury imports.
Step 3: Final Answer:
BOP disequilibrium arises when structural, cyclical, or accidental changes lead to a persistent gap between a nation's foreign exchange earnings and its expenditures.