Posted on

Balance of Payment Adjustment

A balance of payment adjustment measure should be defined as any balance of payment disturbance, which can be deliberately initiated in order to correct some other disturbance.

Therefore a country faced with a persistent balance of payments deficit requires fundamental solutions.

This involves the use of long-term solutions to correct a persistent balance of payment deficit. These include:

Exchange Rate Policy

Foreign exchange rate is the rate at which one currency is exchanged for another. It is the price of one currency in terms of another. For example, the exchange rate could be $1 to ₦100. In this case, ₦100 is equivalent to $1.00. It should be noted that, the foreign exchange rate influences the demand of a country for imports, and the demand of other countries for exports.  If the value of a country’s currency is high, this will increase the demand for foreign currency and consequently increase the imports of a country. But if the value of a country’s currency in relation to others is low, there will be high demand for the country’s exports.

Fixed exchange rate can be determined by countries quoting the prices at which they are willing to buy or sell gold. It can also be determined by the forces of demand and supply in a free market. Over-valuation of the currency may lead to excess imports and reduced exports, giving rise to balance of payments problems.

It is in the light of above, that government adopts an exchange rate policy of devaluation. Devaluation therefore, is a deliberate reduction in the value of a country’s currency in relation to the currencies of other countries. It increases import prices and reduces export prices. This will lead to a higher demand for exports while the country’s demand for imports will decrease. The resultant effect of all these is that there may be an excess of exports over imports, bringing about a solution to the balance of payments problems.

Unfortunately, for a developing country like Nigeria, exchange rate is not a powerful instrument for influencing the outlook of our balance of payments, particularly in the short run. The main reasons are obvious. First, our trade position may not be improved because our export products are highly inelastic in the international market. Secondly, in the short run, the prices of our exports might have been determined in the world markets. Lastly, retaliation by other countries may render devaluation ineffective.

Exchange Control

This is one of the measures taken to correct a balance of payments deficit. It is a means whereby an unfavourable balance of payments is checked by reducing the amount of foreign currencies that can be sold and bought. Exchange control can be categorised into two systems: single rate system and
multiple rate system. The former has one official rate while the latter has more than  one unofficial rate.

Exchange control helps limit the amount of foreign currency that can be spent on imports. Thus, a country faced with a persistent balance of payments deficit can effectively use exchange mechanism to correct it.

Monetary Policy

Monetary policy can be defined as one which has the objective of influencing economic activity through variation in money supply and availability of credit. It constitutes a part of the general macro-economic policy with the main long-term objective of maintaining a satisfactory balance of payments. Therefore, the major approach to curing balance of payments deficit is the raising of interest rate. The Central Bank could use a restrictive monetary policy which increases the level of interest rates. In the final analysis, people and importers will borrow less money because of increase in interest rates. The demand of people for imported goods will be less and imported goods will become relatively more expensive than exports. In the long-run, payments will be brought in line with receipts. This means that the deficit will be self-correcting. Thus, the deficit in the balance of payment will be reduced if not cured.

Fiscal Policy

Fiscal policy refers to the efforts made by the government to erect some tax structure for the nation, determine the amount of tax revenues, and the amount and direction of its expenditures for the purpose of attaining some specific objective. One of those specific objectives is the improvement of balance of payment. In this case, an increase in tariffs, will lead to a fall in imports. A fall in imports will have a favourable effect on the balance of payments. On the other hand, government expenditures include public consumption, investment and transfer payments. A reduction in government expenditure will in the final analysis lead to a fall in imports. Thus, an expenditure reducing policy will have a positive effect on the balance of payments both by reducing imports and by promoting export expansion.

Financing Policy

Short-term deficits in the balance of payments do not pose serious problems. However, they can be financed by use of reserves and international borrowing, or short-term credit from various sources.

READ MORE