Discuss the measures that can be taken by a country seeking to correct its balance of payment deficit.

Answer Details

A balance of payments deficit occurs when a country's total payments to the rest of the world (mainly for imports and other outflows) exceed its total receipts from the rest of the world (mainly from exports and other inflows) over a period. To correct it, a country must either reduce outflows or increase inflows. The main measures are grouped below.

1. Expenditure-reducing (deflationary) measures to cut demand for imports:

• Deflationary fiscal policy: raising taxes and cutting government spending to reduce total demand, which lowers spending on imports.
• Tight monetary policy: raising interest rates and reducing the money supply to curb spending and imports.

2. Expenditure-switching measures to move spending away from foreign goods towards home goods:

• Devaluation of the currency: lowering the external value of the currency makes exports cheaper to foreigners and imports dearer at home, so exports rise and imports fall (provided demand is sufficiently elastic).
• Import tariffs and quotas: taxes and quantity limits on imports to reduce them directly.
• Exchange control: restricting the amount of foreign currency available for imports and other outflows.

3. Measures to increase exports and inflows:

• Export promotion: subsidies, incentives and support to raise the volume and value of exports.
• Diversification of production and exports: to widen the sources of foreign exchange.
• Encouraging import substitution: producing at home goods that were formerly imported.
• Attracting foreign investment, aid and tourism: to bring in foreign exchange on the capital and services accounts.

4. External and financing measures:

• Borrowing from abroad or from the IMF to finance the deficit temporarily.
• Rescheduling of external debt to reduce immediate outflows.

The most suitable mix depends on the cause of the deficit and on how responsive (elastic) the country's exports and imports are to price changes. Some measures, such as tariffs and exchange control, provide short-term relief, while diversification and export promotion address the deficit in the longer term.