1. Fiscal policy:
One of the important functions of the fiscal policy is to promote the welfare of people in general and
particular the proper section for this purpose .modern govts are working in planned way. The govt
mobilizes the funds from various sources like taxes, borrowings and debts. One of the popular sources
is through taxes both direct and indirect .to removes the inequalities of the income and to establish
socialistic of society direct taxes are important.
These objectives are to produce desirable effects and avoid undesirable effects on the national income
production employment and price level .the goal of the fiscal policy in developed countries is to
achieve economic stability ,while in developing countries is to achieve economic development.
Fiscal policy involves designing the tax structure determining tax revenue and handling public
expenditure in such a way that the objective of the full employment is achieved.
The fiscal policy is the part of govt policy which is concerned in raise in revenue through taxation and
deciding the pattern of expenditure. The govt budget is an estimation of govt expenditure and revenue
for ensuring financial year presented to the parliamentary financial ministers.
The budget is divided vertically into revenues and capital again they will be divided into revenue
receipts and expenditure as well as capital receipts and expenditure.
The revenue expenditure includes all current expenditure of govt and capital includes all the capital
transaction of govt.
The revenue receipts includes revenue from taxes while capital receipts include mkt loans, income
from repayments and other receipts such as income from undertakings.
Fiscal policy Merits:
1) Capital Formation: The Fiscal policy of the country has been playing an important role in raising
the rate of capital formation in the public and private sectors. It has created a favorable impact on
public and private sector investment of the country.
2) Mobilization of Resource: the Fiscal policy of the country has been helping to mobilize a
considerable amount of resources through taxation, public debt and other sources for financing its
various developmental projects.
3) Incentives to savings: the fiscal policy of the country has been providing various incentives to
raise the savings rate both in household and corporate sector through various budgetary policy
changes viz. tax exemption, tax concession etc…,
4) Inducement to Private sector: The private sector of the country has been getting necessary
inducements from the fiscal policy of the country to expand its activities. Tax concessions, tax
exemptions, subsidies and so on incorporated in the budgets have been providing adequate incentives
to the private sector units engaged in industry, infrastructure, and export of the country.
5) Reduction of inequality: the Fiscal policy of the country has been making constant Endeavour to
reduce the inequality in the distribution of income and wealth. Progressive taxes on income and
wealth tax exemption, grant and so on are making a concerted effort to reduce such inequalities.
6) Export Promotion: The Fiscal Policy has been making constant efforts to promote through its
various budgetary policies in the form of concessions, subsidies and so on.
7) Alleviation of poverty and Unemployment: It makes constant efforts to alleviate poverty and
unemployment through its various poverty eradication and employment generation programmes.
1. Instability: The Fiscal Policy of the country has failed to help attain stability in various fronts of
the economy. The growing volume of deficit financing has created inflationary rise in price levels.
2. Defective Tax Structure: The Fiscal policy has also failed to provide a suitable tax structure for
the country. The tax structure has failed to raise the productivity of direct taxes.
3. Inflation:- The fiscal policy of the country has failed to contain the inflationary rise in price level.
The increasing volume of public expenditure on non-development heads and deficit financing has
resulted demand-pull inflation.
4. Negative Return of the Public Sector: The negative return on capital invested in the public sector
units has become a serious problem for the Government of Indian. The government has to keep huge
budgetary provisions and thereby creating a huge drainage of scarce resources of the country.
5. Growing Inequality: The fiscal policy of the country has failed to contain the growing inequality
in the distribution of income and wealth throughout the country. The growing trend of tax evasion has
made the tax machinery ineffective for the purpose while the growing reliance on indirect taxes has
made the tax structure regressive.
2.Objectives of Fiscal policy:
The objectives of fiscal policy varied from country to country.they are based on eco.development of
the country. The broad objectives of fiscal policy are as follows
Reduction disparities of income
Economic development of country
Expansion of employment
Correction of disequilibrium in BOP
To mobilize resources for investment govt may go for voluntary as well as compulsory savings it
takes place through public taxations, borrowings, cum voluntary and compulsory savings. As the
per capital income is very low the developing countries voluntary savings does not take place.
The govt can distribute the money to various sectors where they have scarcity.
Economic development and growth
Other objective of physical policy is to promote echo development of country the contribution of
public expenditure to growth depends on its size as well as ratio of productive expenditure to
total expenditure. This investment show positive impact for development of country.
Reduction of disparities of income
Physical policy can be used be the govt to minimum the echo disparity in the society the disparity
lead to political and social interest and generation instability in economy. Govt can reduce the
economic disparity more tax from the luxury people as well as harmful goods. These taxes is
also called as progressive taxation and also take low taxes from poor people.
Expansion of employment
After the great objective of Indian govt is to promote more employment for increasing per capita
income. To increase the level of private expenditure and public expenditure and investment has
to be increase thus physical policy can help in creating an atmosphere where people get more
Fiscal policy helps in insuring price stability where economy is experiencing deflations, budget
should aim at increasing expenditure and creating income for the people who have high income
to consumer and also maintain price stability of commodities at the time of inflation. This is
possible because of fiscal policy contribution.
3. Features of Fiscal policy
The features of fiscal policy can be explained as below
Common according year for income tax:
Taxation policy has adopted standard accounting year April march for the purpose of income tax.
The change is intended to reduce the malpractices and raise revenue of tax.
Long term fiscal policy
Since 1986 budget the govt of India has introduced long term fiscal policy to provide greater
certainties in its budgetary policies and to improve the overall environment of business.
Impact on rural employment
Generation of employment of India has introduced new employment schemes like jawahar rojgar
yojna or strengthened the existing schemes like integrated rural development program or national
rural employment program.
Unaccounted money has been a constant feature of Indians economy. Fiscal measures have
generally failed to reduce the certain of block money.
Reliance on indirect taxes:
The tax policy is increasingly becoming regressive in nature by large dependence on indirect
taxes like excise duty (or) custom duty as compared to that on direct taxes like income
Taxes, corporation tax etc
Inadequate public sector contribution: Contrary to repeated assertion by the govt of India,
public sector continues to be a drain on the meager resources of the govt.
Introduction of MODVAT:
In 1986 the introduction of MODVAT has helped to reduce cumulative impact of indirect
taxes on manufactured products.
4. FISCAL POLICY INSTRUMENTS
The fiscal policy have three types of factors. Those are
1. Public Revenue
2. Public Expenditure
3. Public Debt
The state, in the process of performing its functions and to achieve its targets and objectives, has
to incur a large public expenditure. This expenditure is possible only when there is sufficient
public revenue. Without the revenue, there cannot be expenditure. Revenue is as important of
as production to the economic system.
Taxes are compulsory contributions paid by citizen of the country to the state
Expecting any benefits or return from the state. Every individual enjoys certain benefits, rights
and privileges from the actions and performances of the state and as such, it is the responsibility
of every individual to contribute the treasury a specified amount determined by the state without
anticipating or expecting any benefits or returns.
IMPORTANT TYPES OF TAXATION ARE AS FOLLOWS:
Imposition of tax to regulate industrial production and to control export and import of the goods
is known as “Duty”.
If the tax is levied for a specific purpose then it is known as “cess”.for exampleeduction cess,it is
levied for promoting education in the country.
SURCHARGE: Tax on tax is known as surcharge. If the objective of Fevying higher tax is for
short period of time, then government, resorts to have surcharge.
if tax is levied by municipal corporation or grama panchayat on the goods brought from other
parts of the country by traders for sale into their jurisdiction limits, then it is known as
“octroi”.this tax is also known as entry tax.
It is the tax levied by local bodies or municipalities on the goods leaving for sale from their
boundaries into other parts of the country.
This tax is paid by vehicular travellers.the persons who are travelling in car,bus,jeep etc.For using
the road or bridge to reach their destination have to pay the tax.
Principle of Fairness
Principle of Transparency
Principle of Benefit
Principle of Economy
Principle of Sanction
Nearly two hundred years ago, corresponding to the police character of
the state minimum expenditure by it was considered to be good. Thus even in standard works on
economics, expenditure was considered to be rather unimportant and more more so the public
expenditure .much more attention was given to public revenues and taxation than to public
Principles of Expenditure
These are the basic principles which should be guide or govern public expenditure in an
Principle of Economy:- It lay down that un necessary and waste full expenditure. Should
Principle of Sanction: - the expenditure should be made after evading obtaining proper
authorization and should be incurred of the same purpose for which the sanction or
approval has been obtained.
Principle of benefit:- the expenditure should be in the best interest of the economy and
society, only wovth while projects should be selected on the basis or appropriate cost
Principle of Fairness:- expenditure should be made in such a way that there is equity
economic justice and fairness.
Principle of transparency:- the objectives, policy quantum and direction of public
expenditure should be transparent and understandable.
Classification of Public Expenditure
There are a variety of ways in which public expenditure can be classified bu broadly it is
classified under the following heads
According to Authority which spends the money
1. federal or union o9r central expenditure
2. state or provincial expenditure
3. Local expenditure or expenditure of municipalities and other local bodies.
According to the object of Expenditure:1. Development activities like providing subsidies elective power, transport service,
welfare activities employment opportunities and price stability etc.
2. Non- developmental activities like money spent on administrative machinery, law and
order interest payment on public debt and defense.
According to the nature of Expenditure:1. Revenue expenditure: Revenue expenditure is current example, administrative and
maintenance expenditure. This expenditure is of a recurring type.
2. Capital expenditure:- Capital expenditure is of capital nature and is incurred once for
all. It is non recurring expenditure, Ex: Expenditure in building multipurpose.
Projects or a setting up big factors like steel plant, money spent on land, machinery
Developmental activities financed by Public expenditure
Development of infrastructure:Development of infrastructural facilities which include development of power project,
railways road, transportation system, bridges, dams, irrigation projects, hospitals,
educational institutions and so on. Involves huge expenditure by the government because
private investors are reluctant to invest in these areas considering their low rate of
profitability and high risk.
Development of Public enterprises:The development of heavy and basic industries is very important for the development of
an underdeveloped country. But the establishment of these industries involves huge
investment and a considerable proportion of risk. Naturally the private sector can’t take
the responsibility to develop these industries. The development of these industries has
become a responsibility of the government of India. Particularly since the introduction of
the industrial policy of 1956. a significant portion of the public expenditure has been
utilized for the establishment and improvement of these public enterprises.
Support to private sector:Providing the necessary support to the private sector for the establishment of industry and
other projects is another important objective of the public expenditure policy formulated
by the government of India.
Social Welfare and employment programmes:Public expenditure policy pursued by the government of India is its growing involvement
in attaining various social welfare programmes and employment generation programmes.
Increase Production:Public expenditure contributes to production through a large number of public enterprises
both in industries and agriculture.
Promote price stability:Increases in public expenditure relieves the economy from the dilemma of depression and
conversely public expenditure can be scaled down when there is a fear of inflationary rise
Promote balanced growth:There is a tendency to use economic resources for the further development of already
Reduce inequality of income:- Public expenditure is to reduce the inequality of income.
Public Debt: Public debt in the India context refers to the borrowings of the central and state
government. Gross public debt is the gross financial liability of the government.
Types of public debt:1) short term debt
Maturity up to one year
Common instruments are treasury bills
2) Floating debt:
No specific date of maturity
Repayable subject to different terms and conditions’
3) Funded debt:i)
cheated by the sale of government securities issued to pay floating obligations
Maturity exceeds on one year and in actual practice may even go up to 30 years
4) Refunded debt:
replacing maturing securities with new securities
Internal debt:- The different types if internal debts are
Market Loans: these are the loans with the maturity of 1 year or more at the time of issue and general
interest. Market loans are raised by central government almost every year for open market by sale of
Bonds: the central government raises funds by issue of specific types of bond as and when required
like gold bond 1998.
Treasury Bill:- These have been major sources of short term funds for the governments to bridge the
gap between revenue and expenditure . Treasury bills have a maturity of 91 or 182 or 364 days.
Special Floating and other loans: they represent the contribution of Govt. of India towards the
capital of International Financial Institution such as IMF and World Bank
Special Securities issued to RBI: Issue of special security is a means of which government takes
loans of temporary and short term nature from the RBI .
Securities against small savings: these are the national savings fund converted into central
Small Savings raised by such schemes as national small savings certificates into central government
Provident Funds: State and public provident funds are important sources of public debt.
6) External debt is raised in foreign currency and a substantial part of it is also repayable in foreign
currency. This is because of NRI’.
Role of Debt:- Public debt plays an important role in the economy. The net effect of the borrowing
also depends upon the sources from which they come.
If the government reduces its borrowings from the market and the public reduces its own consumption
and lends its savings to the government the result will be a net increase in the rate of saving.
If money is borrowed from the central bank it results in an addition to aggregate money supply in the
Critical analysis of the recent policy of government of India.
One important aspect of new economic policy (1991) adopted by government of India is
fiscal reforms. Main objective of fiscal reforms is to bring down the fiscal deficit.
Simplification of Taxation:
With a view to simplifying the taxation system as recommended by Rajachelliah taxation
reforms committee, ex- finance minister Dr. Manmohan Singh and finance minister
Sh.Chidhambaram have taken several steps.
Improving tax to GDP rates:
In year 2002-03 this ratio was 14.4. in the year 2007-08 it improved to 17.8.
Reduction in rates of direct taxes:
In 1997-98 budget, the maximum rate of income tax had been reduced to 30%. In the budget
for the year 2008-09, maximum rate of income tax is 30%. Rate of corporation tax has also been
reduced. As a result tax revenue has increased. In 1991-91 direct tax revenue was 1.9%. It rises to
5.1% in 1990-91 year it increase to 19% in 2007-08 it rise to 48.8%.
Reforms in indirect taxes: Under reforms concerning customs, import duties were reduced so as to
bring down the cost of production. It is for the benefits of customers. In year 2001-02, government
adopted central added value tax (CENVAT) vat is charged on value additions at each stage of
production or distribution.
Introduction of service tax:
In the year 1994-95, service tax has been started in India. In year 2007-08 rate of service tax
was 12%, in 2009 it reduce to 10%.Intially this was applicable for few sectors but now many services
have been covered under this tax.
Reduction in subsidies:
Central government has to make huge payments by way of subsidies, for instance, fertilizer
subsidies etc. in 1991-91 subsidies constituted 2.3% of GDP but in 2007-08 fall to 1.1% in 2008-09 it
again increased to 2.4% of GDP.
Improvement in tax collection
For improving tax collection and to check tax evasions various schemes have been launched
by government from time to time wise allotting permanent account, permanent account number
(PAN) e- payment facilities etc.
Closure of sick public sector companies:
Government has been closing loss making and sick public sector companies. This step has
been taken to reduce the burden of these loss making units on government.
Disinvestment of public sector units:
Disinvestment here refers to selling the share of public sector units to private hands. Through
disinvestment government gets huge funds. This has enabled the government to overcome financial
Efforts to reduce government administration expenses:
For this government has offered attractive voluntary retirement scheme to its employees to
overcome the problem of over staffing.governament has banned or reduced sanctioning new posts in
some of its departments.
Reduction in central tax:
Government has reduced CST from 3%to 2%from April 1,2009.this tax has been reduced to 1%and
from April 2010 CST would be abolished.
Introduction to goods service tax:
Central government is gradually reducing central sales tax, excise tax on goods and is increasing
service tax rate.governament is moving towards imposing a uniform tax on goods and services named
GST with effect from April 1,2010.
Enactment of fiscal responsibility and budget management act:
Government has enacted fiscal policy responsibility and budget management act ,2003.the purpose of
this act is to reduce fiscal deficit.
“Talk less think more act wisely”
STRUCTURE OF BALANCE OF PAYMENTS:The Balance of Payment (BOP) of a country is a systematic account of all economic
transactions between a country and the rest of the world, undertaken during a specific period
of time. BOP is the difference between all receipts from foreign countries and all payments to
foreign countries. If the receipts exceed payments, then a country is said to have favourable
BOP, and vice versa.
According to Charles Kindle Berger "The BOP of a country is a systematic recording of all
economic transactions between residents of that country and the rest of the world during a
given period of time".
The Balance of payments record is maintained in a standard double - entry book - keeping
method. International transactions enter into record as credit or debit. The payments received
from foreign countries enter as credit and payments made to other countries as debit. The
following table shows the elements of BOP.
BALANCE OF PAYMENTS ACCOUNT
Export of goods.
Imports of goods.
Trade Account Balance
Export of services.
Import of services.
Interest, profit and dividends
Interest, profit and dividends paid.
Current Account Balance
4. Unilateral receipts. (1 to 4)
Short term borrowings.
Short term lending.
Medium and long term borrowing.
Capital Account Balance (5 to 7)
Errors and omissions.
Change in reserves. (+)
Errors and omissions.
Medium and long term lending.
Change in reserve (-)
Trade Balance :Trade balance is the difference between export and import of goods, usually referred
as visible or tangible items. If the exports are more than imports, there will be trade surplus
and if imports are more than exports, there will be trade deficit. Developing countries have
most of the time suffered a deficit in their balance of payments. The trade balance forms a
part of current account. In 2008-09, trade deficit of India was 118.6 US $ billion.
Current Account Balance :It is the difference between the receipts and payments on account of current account
which includes trade balance. The current account includes export of services, interest,
profits, dividends and unilateral receipts from abroad and the import of services, profits,
interest, dividends and unilateral payments abroad. There can be either surplus or deficit in
current account. When debits are more than credits or when payments are more than receipts
deficit takes place. Current account surplus will take place when credits are more and debits
The current account
The current account records the movement of all goods and services into and out of the UK.
Some of you may be thinking, "what happened to the visibles and invisibles?" While some
examiners might let you get away with using these terms, these old terms have not been used
officially for almost five years!
Trade in goods
The visible section is now called the trade in goods section. Both names are equally easy to
remember. This section records all trade in goods, hence the name! Another way of thinking
about it is that all goods are visible, hence the old name.
Trade in services
In the days of 'visible' and 'invisible', services, investment income and transfers were all
lumped in together in the 'invisibles' section. The current account only had two sections:
visible and invisible.
This also used to be under the old 'invisibles'. You may know it as 'IPDs' or interest, profit
and dividends. The new title of investment income makes sense because interest, profit and
dividends are all forms of income earned on investments. Interest is earned on bank deposits
and government bonds, profit is earned from investments in a business enterprise and
dividends are earned annually on shares.
This also used to be under the old 'invisibles'. Transfers are now separated into a separate
section because they are different in the sense that they do not reflect any actual trade. This
section is split into two; government transfers and transfers made by other sectors
Capital Account Balance :It is the difference between receipts and payments on account of capital account. The
transactions under this title involves inflows and outflows relating to investments, short term
borrowings I lending, and medium term to long term borrowings / lending. There can be
surplus or deficit in capital account. When credits are more than debits surplus will take place
and when debits are more than credits deficit will take place. In 2009-10. India’s capital
account surplus was 51.8 US $ billion.
This refers to money that flows across national boundaries for the purpose of investing in a
business enterprise. Essentially, it records the transfer of ownership of UK or foreign
businesses. It also records money invested abroad for a new business venture. When Marks &
Spencer build a new store in, say, Hong Kong, this will count as an outflow of money from
the UK (-) in the direct investment section of the capital account. When Nissan built its
factory in Sunderland, this counted as an inflow of money (+) in the same section.
This is money that flows across national boundaries for the purpose of investing in shares and
bonds. If someone in the UK buys some shares in an American company, this will count as
an outflow of money from the UK (-) in the portfolio investment section of the capital
account. If an American buys some shares in a British company, this will count as an inflow
of money into the UK (+) in the same section
This section can be quite hectic because it includes short-term 'hot money' banking flows. It
also includes net government borrowing from foreigners.
This refers to the reserves of gold and foreign currencies held by the Bank of England for use
by the government. The government might use some of their reserves to artificially
manipulate the value of the pound; although this rarely happens any more because the pound
is freely floating and the government do not seem particularly keen to intervene in currency
Errors and Omissions :The double entry book - keeping principle states that for every credit, there is a
corresponding debit and therefore, there should be a balance in BOP as well. In reality BOP
may not balance, due to errors and omissions. Errors may be due to statistical discrepancies
(differences) and omissions may be due to certain transactions may not get recorded. For Eg.,
remittance by an Indian working abroad to India may not get recorded etc. If the current and
capital account shows a surplus of 20,000 $, then the BOP should show an increase of 20,000
$. But, if the statement shows an increase of 22,000 $, then there is an error or omission of
2,000 $ on credit side
Foreign Exchange Reserves :The balance of foreign exchange reserve is the combined effect of current and capital
account balances. The reserves will increase when:a)
The surplus capital account is much more than the deficit in current account.
The surplus in current account is much more than deficit in capital account.
Both the current account and capital account shows a surplus.
In 2009-10 India’s foreign exchange reserves increased by 13.4 US $ billion.
INDIA’S BALANCE OF TRADE:Balance of trade is the difference between exports and imports. India’s Balance of
trade is mostly in deficit. This is due to low share off Exports in world market. Imports are
high due to petroleum, oil and lubricant products.
INDIA’S BALANCE OF TRADE (US $ Billion)
India’s export performance is poor. At present, India’s share off world export trade is
1%. The share of exports of other developing countries is much more than India.
REASONS FOR POOR PERFORMANCE OF INDIA’S EXPORT TRADE
There are Several reasons for India’s Poor performance. Some off them are:
Export - Related Problems :-
1 High Prices :As compared to other Asian Countries the price of Indian goods is high. Prices are high
due to documentation formalities, high transaction costs & also to make higher profits.
Poor - Quality :-
Many Indian exporters do not give much importance to quality control, so their products
are of poor quality. Due to low quality many times Indian goods are rejected & sent back to
India by foreign buyers.
Poor Negotiation Skills :Indian exporters lack Negotiation Skills due to poor training in Marketing. They fail to
Convince & induce the foreign buyers to place orders.
Inadequate Promotion :For Export Marketing, Promotion is important. Many Indian Exporters do not give much
importance to promotion. A good no. of Indian exporters are not professional in advertising
& Sales promotion. They do not take part in trade fairs & exhibitions.
Poor follow-up of sales :Indian exporters are ineffective in providing after-sale-service. They do not bother to find
out the reactions of buyers after sale. This results in poor performance of India’s export trade.
Good Domestic Market
Sellers find a ready market for their goods within the country, so they do not take patns to
get orders from overseas markets.
Number of formalities
There are number of documentation & other formalities due to which the some rnarketers
do not enter the export field. So there is a need to simplify formalities.
Problem of Trading Blocs
Trading blocs reduce trade barriers on member nations, but they impose trade barriers on
non-members. As India is not a member of some powerful trading blocs, it has to face some
Some of the overseas buyers have a negative attitude towards Indian goods. They feel that
Indian goods are inferior goods. Thus there is a need to correct this attitude.
Indian infrastructure is poor. Indian exporters find it difficult to get orders & also to
deliver them at time.
EQUILIBRIUM AND DISEQUILIBRIUM IN BOP :-
Balance of payments is the difference between the receipts from and payments to
foreigners by residents of a country. In accounting sense balance of payments, must always
balance. Debits must be equal to credits. So, there will be equilibrium in balance of
Symbolically, B = R - P
Where : - B = Balance of Payments
R = Receipts from Foreigners
P = Payments made to Foreigners
When B = Zero, there is said to be equilibrium in balance of payments.
When B is positive there is favourable balance of payments; When &. B is negative
there is unfavourable or adverse balance of payments.' When there is a surplus or a deficit in
balance of payments there is said : to be disequilibrium in balance of payments. Thus
disequilibrium refers to imbalance in balance of paymen
TYPES OF DISEQUILIBRIUM IN BOP
The following are the main types of disequilibrium in the balance of payments:1.
Structural Disequilibrium :Structural disequilibrium is caused by structural changes in the economy affecting
demand and supply relations in commodity and factor markets. Some of the structural
disequilibrium are as follows :a.
A shift in demand due to changes in tastes, fashions, income etc. would
decrease or increase the demand for imported goods thereby causing a
disequilibrium in BOP.
If foreign demand for a country's products declines due to new and cheaper substitutes
abroad, then the country's exports will decline causing a deficit.
Changes in the rate of international capital movements may also cause structural
d. If supply is affected due to crop failure, shortage of raw-materials, strikes, political
etc., then there would be deficit in BOP.
e. A war or natural calamities also result in structural changes which may affect not only
but also factors of production causing disequilibrium in BOP.
Institutional changes that take place within and outside the country may result in BOP
disequilibrium. For Eg. if a trading block imposes additional import duties on products
imported in member countries of the block, then the exports of exporting country would be
restricted or reduced. This may worsen the BOP position of exporting country.
Cyclical Disequilibrium :Economic activities are subject to business cycles, which normally have four phases
Boom or Prosperity, Recession, Depression and Recovery. During boom period, imports may
increase considerably due to increase in demand for imported goods. During recession and
depression, imports may be reduced due to fall in demand on account of reduced income.
During recession exports may increase due to fall in prices. During boom period, a country
may face deficit in BOP on account of increased imports.
Cyclical disequilibrium in BOP may occur because
a. Trade cycles follow different paths and patterns in different countries.
b. Income elasticities of demand for imports in different countries are not identical.
c. Price elasticities of demand for imports differ in different countries.
Short - Run Disequilibrium :This disequilibrium occurs for a short period of one or two years. Such BOP
disequilibrium is temporary in nature. Short - run disequilibrium arises due to unexpected
contingencies like failure of rains or favourable monsoons, strikes, industrial peace or unrest
etc. Imports may increase exports or exports may increase imports in a year due to these
reasons and causes a temporary disequilibrium exists.
International borrowing or lending for a short - period would cause short - run
disequilibrium in balance of payments of a country. Short term disequilibrium can be
corrected through short - term borrowings. If short - run disequilibrium occurs repeatedly it
may pave way for long - run disequilibrium.
Long - Run I Secular Disequilibrium :Long run or fundamental disequilibrium refers to a persistent deficit or a surplus in
the balance of payments of a country. It is also known as secular disequilibrium. The causes
of long - term disequilibrium are
a. Continuous increase in demand for imports due to increasing population.
b. Constant price changes - mostly inflation which affects exports on continuous basis.
c. Decline in demand for exports due to technological improvements in importing countries,
such the importing countries depend less on imports.
The long run disequilibrium can be corrected by making constant efforts to increase
exports and to reduce imports.
Monetary disequilibrium takes place on account of inflation or deflation. Due to
inflation, prices of products in domestic market rises, which makes exports expensive. Such a
situation may affect BOP equilibrium. Inflation also results in increase in money income with
people, which in turn may increase demand for imported goods. As a result imports may turn
BOP position in disequilibrium.
Exchange Rate Fluctuations :A high degree of fluctuation in exchange rate may affect the BOP position. For Eg. if
Indian Rupee gets appreciated against dollar, then Indian exporters will receive lower
amounts of foreign exchange, whereas, there will be more outflow of foreign exchange on
account of higher imports. Such a situation will adversely affect BOP position. But, if
domestic currency depreciates against foreign currency, then the BOP position may have
CAUSES OF DISEQUILIBRIUM IN BOP
Any disequilibrium in the balance of payment is the result of imbalance between
receipts and payments for imports and exports. Normally, the term disequilibrium is
interpreted from a negative angle and therefore, it implies deficit in BOP.
The disequilibrium in BOP is caused due to various factors. Some of them are
Import - Related Causes
The rise in imports has been the most important factor responsible for large
BOP deficits. The causes of rapid expansion of imports are :Population Growth
Population Growth may increase the demand for imported goods such as food
items and non food items, to meet their growing needs. Thus, increase in imports may lead to
Increase in development programmes by developing countries may require
import of capital goods, raw materials and technology. As development is a continuous
process, imports of these items continue for a long time landing the developing countries in
Imports Of Essential Items
Countries which do not have enough supply of essential items like Crude oil
or Capital equipments are required to import them. Again due to natural calamities
government may resort to heavy imports, which adversely affect the BOP position.
Reduction Of Import Duties
When import duties are reduced, imports becomes cheaper as such imports
increases. This increases the deficit in BOP position.
Inflation in domestic markets may increase the demand for imported goods,
provided the imported goods are available at lower prices than in domestic markets.
An increase in income coupled with awareness of higher living standard of
foreigners, induce people at home to imitate the foreigners. Thus, when people become
victims of demonstration effect, their propensity to import increases.
Export Related Causes :-
Even though export earnings have increased but they have not been sufficient enough
to meet the rising imports. Exports may reduce without a corresponding decline in imports.
Following are the causes for decrease in exports
Increase In Population :Goods which were earlier exported may be consumed by rising population.
This reduces the export earnings of the country leading to BOP disequilibrium.
When there is inflation in domestic market, prices of export goods increases. This
reduces the demand of export goods which in turn results in trade deficit.
Appreciation Of Currency :-
Appreciation of domestic currency against foreign currencies results in lower foreign
exchange to exporters. This demotivates the exporters.
Discovery Of Substitutes :-
With technological development new substitutes have come up. Like plastic for
rubber, synthetic fibre for cotton etc. This may reduce the demand for raw material
Technological Development :-
Technological Development in importing countries may reduce their imports. This
can be possible when they start manufacturing goods which they were exporting earlier. This
will have an adverse effect on exporting countries.
Protectionist Trade Policy :-
Protectionist trade policy of importing country would encourage domestic producers
by giving them incentives, whereas, the imports would be discouraged by imposing high
duties. This will affect exports.
Other Causes :-
Flight of Capital
Due to speculative reasons, countries may lose foreign exchange or gold stocks.
Investors may also withdraw their investments, which in turn puts pressure on foreign
Globalisation and the rules of WTO have brought a liberal and open environment in
global trade. It has positive as well as negative effects on imports, exports and investments.
Poor countries are unable to cope up with this new environment. Ultimately they become
loser and their BOP is adversely affected.
International trade is also affected by Business cycles. Recession or depression in one
or more developed countries may affect the rest of the world. The negative effects of trade
cycle (low income, low demand, etc.) are transmitted from one country to another. For eg.
The current financial crisis in U.S.A. is affecting the rest of the world.
Many countries in recent years are undergoing structural changes. Their economies
are being liberalised. As a result, investment, income and other variables are changing
resulting in changes in exports and imports.
The existence of political instability may result in disrupting the productive apparatus
of the country causing a decline in exports and increase in imports. Likewise, payment of war
expenses may also serious affect disequilibrium in the country’s BOP. Thus political factors
may also produce serious disequilibrium in the country’s BOPs.
MEASURES TO CORRECT DISEQUILIBRIUM IN BOP :-
Any disequilibrium (deficit or surplus) in balance of payments is bad for normal
internal economic operations and international economic relations. A deficit is more harmful
for a country’s economic growth, thus it must be corrected sooner than later. The measures to
correct disequilibrium can be broadly divided into four groups
Monetary Measures :1)
Monetary Policy :The monetary policy is concerned with money supply and credit in the economy. The
Central Bank may expand or contract the money supply in the economy through appropriate
measures which will affect the prices.
If in the country there is inflation, the Central Bank through its monetary policy will
make an attempt to reduce inflation. The Central Bank will adopt tight monetary policy.
Money supply will be controlled by increase in Bank Rate, Cash Reserve Ratio, Statutory
The monetary policy measures may reduce money supply, and encourage people to
save more, which would reduce inflation. If inflation is reduced, the prices of domestic
market will decrease and also that of export goods. In foreign markets there will be more
demand for export goods, which would correct BOP disequilibrium.
During deflation the Central Bank of the country may adopt easy monetary
policy. It will try to increase money supply and credit in the economy, which would increase
investment. More investment leads to more production. Surplus can be exported, which in
turn may improve BOP position.
Fiscal policy is government's policy on income and expenditure. Government
incurs development and non - development expenditure,. It gets income through taxation and
non - tax sources. Depending upon the situation governments expenditure may be increased
During inflation the government may adopt easy fiscal policy. The tax rates
for corporate sector may be reduced, which would encourage more production and
distribution including exports. Increased exports will bring more foreign exchange there by
making the BOP position favourable.
During deflation the government would adopt restrictive fiscal policy.It may
impose additional taxes on consumers or may introduce tax saving schemes. This may reduce
the consumption of citizens, which in turn may enable more export surplus.
To restrict imports the government may also impose additional tariffs or customs
duties which may improve the BOP position.
Exchange Rate Policy
Foreign exchange rate in the market may directly or indirectly be influenced by the
When foreign exchange problem is faced by the country, the government tries to
reduce imports and .increase exports. This is done through devaluation of domestic currency.
Under devaluation, the- government makes a deliberate effort to reduce the value of home
country. If devaluation is carried out, then the exports will become cheaper and imports
costlier. This is turn will help to reduce imports and increase exports.
Depreciation like devaluation lowers the value of domestic currency or increases the
value of foreign currency. Depreciation of a country's currency takes place in free or
competitive foreign exchange market due to market forces. Depreciation and devaluation
have the same effect on exchange rate. If there is high demand for foreign currency than its
supply, it will appreciate and vice versa. However, in several countries the system of
managed flexibility is followed. If there is more demand for foreign exchange, the central
bank will release the foreign currency in the market from its reserves so as to reduce the
appreciation of foreign currency. If there is less demand for foreign exchange, it will
purchase the foreign currency from market so as to reduce the depreciation of foreign country
and appreciation of domestic currency.
Due to devaluation and depreciation of domestic currency, the exports become
cheaper and imports become expensive. This helps to increase exports.
Non-Monetary / General Measures :
A deficit country along with monetary measures may adopt the following nonmonetary measures too, which will either restrict imports or promote exports.
Tariffs refer to duties on imports to restrict imports. Tariff is a fiscal device which
may be used to correct an adverse balance of payments. The imposition of import duties will
raise the prices of imports. This will lead to a reduction in demand for imports thereby
improving the balance of payments position.
Under Quota System, the government may fix and permit the maximum quantity or
value of a commodity to be imported during a given period. By restricting imports through
quota system, the deficit is reduced and the balance of payments position is improved.
Export Promotion :-
The government may introduce a number of export promotion measures to encourage
exporters to export more so as to earn valuable foreign exchange, which in turn would
improve BOP Situation. Some of the incentives are Subsidies, Tax Concessions, Grants,
Octroi refund, Excise exemption, Duty Drawback, Marketing facilities etc.
Governments, especially, that of the developing countries may encourage import
substitution so as to restrict imports and save valuable foreign exchange. The government
may encourage domestic producers to produce goods which were earlier imported. The
domestic producers may be given several incentives such as Tax holiday, Cash Subsidy,
Assistance in Research & Development, Providing technical assistance, Providing Scarce
CONCLUSION :From the above measures it is clear that more exports with import substitution based
on economic strength of the country are the real effective solutions to correct the
disequilibrium in the balance of payments