Question

In: Economics

Most developing countries have experienced continuous current account deficits since the early 1980s. What do you...

Most developing countries have experienced continuous current account deficits since the early 1980s. What do you think are the main causes for the deficits? What would be the consequences of continuous current account deficits? Discuss the options for financing a typical balance of payments deficit.

Expert Solution

A current account deficit occurs if value of imports exceed the value of exports.most of the developing countries have experienced continuous current account deficits since the 1980s. Following are the reasons for that.

* Economic growth.

The developing countries on the path of Economic growth.with the increase in national income, disposable income will also be high which creates a rise in aggregate demand. When dmestic producers aren't able to meet the high demand , it leads to an increase in imports .

* Higher inflation

Inflation makes exports less competitive and imports more competitive.

* Overvalued exchange rate

Overvalued exchange rate undermines export profitability and makes imports look cheaper.

* Low invest in export sectors

As a result export Industries find it difficult to stand cut throat competition

* Inability to meet domestic demand

Developing countries also suffer from the absence of proper and efficient Industries to meet their own demand for commodities

> current deficit won't be a serious issue in short run .But prolonged current account deficits will have the following consequences

* It will lead to depreciation in exchange rate and cost push inflation.

* It will be considered as a sign of unbalanced and uncompetitive economy

* If financed through borrowing , countries will be burdened with high interest payments.

* Foreign dependence will increase and the country will end up losing its independence.

Following methods can be adopted to deal with a typical balance of payment deficit

*If the country is a member of organizations like International monetary fund, it may borrow money in foreign currencies.

* The country can also seek help from other foreign nations.

*In order to correct balance of payment deficit , the country can introduce trade policy measures expanding exports and reducing imports

* The country should also adopt monetary and fiscal policies that aim at reducing aggregate Expenditure in the Economy.( Tight monetary policy and contractionary fiscal policy)

* Introduction of Expenditure switching policies will lower the price of Exports which will encourage the exports of a country.

*There is another method called exchange control . Exchange controls are government imposed restrictions on the movement of currency between countries.

Maintaining a good balance of payment position is necessary because balance of payment of a country reveals it's financial and economic status.

Rahul Sunny answered 6 months ago

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