Question

illsutrate and explain with an appropriate diagram the concept of a BOP deficit. Suggest two ways the Boc could eliminate the BOP deficit.

Answer 1

Answer - Deficit in BoP refers to a situation when receipts of the country arising out of autonomous transactions are less than the corresponding payments to the rest of the world during the period of an accounting year. It highlights our net liabilities towards rest of the world.
There is positive as well as negative significance of deficit in BoP. The positive significance is that, BoP deficit may be occurring on account of such capital imports which are essential to speed up the process of growth and development in the economy. The negative significance is that it highlights our liabilities to the rest of the world. Greater the liability, greater is the strain on our GDP by the way of payments to the rest of the world.

Two ways the boc could eliminate the BOP deficit-

1.Deflation means falling prices. Deflation has been used as a measure to correct deficit disequilibrium. A country faces deficit when its imports exceeds exports.Deflation is brought through monetary measures like bank rate policy, open market operations, etc or through fiscal measures like higher taxation, reduction in public expenditure, etc. Deflation would make our items cheaper in foreign market resulting a rise in our exports. At the same time the demands for imports fall due to higher taxation and reduced income. This would built a favourable atmosphere in the balance of payment position. However Deflation can be successful when the exchange rate remains fixed.

2.Exchange control- It is an extreme step taken by the monetary authority to enjoy complete control over the exchange dealings. Under such a measure, the central bank directs all exporters to surrender their foreign exchange to the central authority. Thus it leads to concentration of exchange reserves in the hands of central authority. At the same time, the supply of foreign exchange is restricted only for essential goods. It can only help controlling situation from turning worse. In short it is only a temporary measure and not permanent remedy.