Managing Balance of Payment Deficit
Introduction
When the exchange rates are not stabilized by government authorities, the Flexible Exchange market closely resembles the theoretical model of perfect competition. There will be a large number of buyers and sellers who act as price takers. Accordingly, the exchange rates are determined by demand and supply in the Flexible Exchange market. In cases of Fixed Exchange rates, government officials try to keep the rate stable and have to get rid of the excess supply or demand at specific prices using international reserve assets. Debit transactions involve payments by domestic residents to foreign residents (i.e. imports of merchandise, foreign transportation services, purchases of local residents traveling abroad, foreign investment by home residents). Credit transactions, on the other hand, involve receipts by domestic residents from foreign residents. These factors and modifications can directly cause a deficit in Balance of Payment if improperly managed ().
Tariffs and Quotas
Government has the options of imposing tariffs on a specific situation. According to on his upcoming book “Advanced International Trade: Theory and Evidence”, there are three situations of this imposition of tariffs: (a.) to protect fledging domestic industries from foreign competition; (b.) to protect aging and inefficient domestic industries from foreign competition; and (c.) to protect domestic producers from dumping by foreign companies or governments. Apparently, the implication of tariffs and quotas on imports would significantly facilitate immediate domestic recovery in Balance of Payment deficit
Managing the Balance of Payment Deficit
As the Balance of Payment is getting worse, it appears that the risk of a crisis is indeed serious. The present situation of the subsidiary would be less sustainable without proper management of the deficit. The aim would be to recover, minimize, and profit from the current loss by making it an Ownership Society rather than Sharecropper’s Society (perpetually paying tribute to foreign creditors and owners).
The initial solution would be the depreciation of the exchange rate of the host country. Depreciation or devaluation of the domestic currency carries two advantages for the subsidiary. Firstly, it will improve the competitiveness of domestic products, and eventually lead to an increase in exports and lower imports. A government’s implementation of tariffs and quotas on imports would also greatly help in achieving this measure. It would be a good way to shrink the current account deficit without any significant negative impact on the domestic economy. Secondly, it would reduce the burden of the current debt faced by the subsidiary. The exchange rate is not more of a cause but an indication. What really drives a current account deficit is the balance between the subsidiary savings and investment – put differently, the balance between domestic spending and income.
The government then plays a vital role of implementing reforms to contain the increasing deficits. Their job would not be only through tariffs and quotas on imports but harmonizing currency interventions to manage the exchange rate and ensure that any further depreciation of the currency will not turn into a destabilizing run. When this cooperation between the subsidiary and the government will be met, there will then be an increase in national savings thus reducing dependence on foreign borrowing.
Credit:ivythesis.typepad.com
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