(a) Explain the term balance of payments deficit (b) What four measures can be taken to reduce the balance of payments deficit of a country?

Answer Details

(a) A balance of payments deficit exists when a country's total payments to other countries (for imports of goods and services, and capital outflows) exceed its total receipts from them (from exports and capital inflows) over a given period. In other words, the country's foreign expenditure is greater than its foreign earnings, so it is a net debtor for that period, usually shown as an overall (or current-account) deficit financed by drawing on reserves or borrowing.

(b) Four measures to reduce a balance of payments deficit:

• Reduce imports: Impose or raise tariffs, quotas and import restrictions, and promote import-substitution industries and local production.
• Promote exports: Give incentives such as export subsidies, better quality and diversification of exports to earn more foreign exchange.
• Devaluation of the currency: Lowering the external value of the currency makes exports cheaper and imports dearer, improving the balance (provided demand is sufficiently elastic).
• Deflationary (contractionary) policies: Reduce domestic demand and incomes through higher taxes and reduced government spending or tighter money, cutting the demand for imports. (Exchange control and borrowing from abroad or the IMF can also help in the short run.)