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Factors Affecting Balance of Payments

Factors Affecting Balance of Payments

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Published by ashu khetan

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Published by: ashu khetan on May 30, 2010
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03/24/2014

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F
ACTORS
A
FFECTING
B
ALANCE
 
OF
P
AYMENTS
Export of Goods And Services
The Prevailing Exchange Rate of the Domestic Currency:
A lower value of thedomestic currency results in the domestic price getting translated into a lowerinternational price. This increases the demand for domestic goods and services andhence their export. This is likely to result in a higher demand for the domesticcurrency. A higher exchange rate would have an exactly opposite effect.
Inflation Rate:
 The inflation rate in an economy vis-à-vis other economies affects theinternational competitiveness of the domestic goods and hence their demand. Higherthe inflation, lower the competitiveness and lower the demand for domestic goods. Yet, a lower demand for domestic goods and services need not necessarily mean alower demand for the domestic currency. If the demand for domestic goods isrelatively inelastic, then the fall in demand may not offset the rise in price completely,resulting in an increase in the value of exports. This would end up increasing thedemand for the local currency. For example, suppose India exports 100 quintals of wheat to the US at a price of Rs.500 per quintal. Further, assume that due todomestic inflation, the price increases to Rs.530 per quintal and there is a resultantfall in the quantity demanded to 96 quintals. The exports would increase fromRs.50,000 to Rs.52,800 instead of falling.
World Prices of a Commodity
: If the price of a commodity increases in the worldmarket, the value of exports for that particular product shows a correspondingincrease. This would result in an increase in the demand for the domestic currency. Afall in the demand for domestic currency would be experienced in case of a reductionin the international price of a commodity. This impact is different from the previousone. The previous example considered an increase in the domestic prices of all goodsproduced in an economy simultaneously, while this one considers a change in theinternational price of a single commodity due to some exogenous reasons.
Incomes of Foreigners:
 There is a positive correlation between the incomes of theresidents of an economy to which the domestic goods are exported, and exports.Hence, other things remaining the same, an increase in the standard of living (andhence, an increase in the incomes of the residents) of such an economy will result inan increase in the exports of the domestic economy Once again, this would increasethe demand for the local currency.
Trade Barriers:
Higher the trade barriers erected by other economies against theexports from a country, lower will be the demand for its exports a hence, for itscurrency.
 
Imports of Goods and Services
Imports of goods and services are affected by the same factors that affect theexports. While some factors have the same effect on imports as on exports, so of them have an exactly opposite effect.
Value of the Domestic Currency:
An appreciation of the domestic currency resultsin making imported goods and services cheaper in terms of domestic currency, henceincreasing their demand. The increased demand imports results in an increasedsupply of the domestic currency depreciation of the domestic currency have anopposite effect.
Level of Domestic Income
: An increase in the level of domestic income increasesthe demand for all goods and services, including imports and it results in an increasedsupply of the domestic currency.
International Prices:
 The. International demand and supply positions deter theinternational price of a commodity. A higher international price would translate into ahigher domestic price. If the demand for imported goods is inelastic, this would resultin a higher domestic currency value of in increasing the supply of the domesticcurrency.In case of the demand elastic, the effect on the supply of the domestic currency woulddepend the effect on the domestic currency value of imports.
Inflation Rate:
A domestic inflation rate that is higher than the inflation of othereconomies, would result in imported goods and services bee relatively cheaper thandomestically produced goods and services would increase the demand for the former,and hence, the supply domestic currency.
Trade Barriers:
 Trade barriers have the same effect on imports exports - higher thebarriers, lower the imports, and hence, lower the supply of the domestic currency.
Income on Investments
Both payments and receipts on account of interest, dividends, profits etc., depend onthe level of past investments and the current rates of return that can be earned in aneconomy. For payments, it is the level of past foreign investments and the currentdomestic rates of return; while for the receipts it is the past domestic investments inforeign economies and the current foreign rates of return, which are relevant.
Transfer Payments
 Transfer payments are broadly affected by two factors. One is the number of migrantsto or from a country, who may receive money from or send money to relatives. Thesecond is the desire of a country to generate goodwill by granting aids to othercountries along with the economic capability to do so, or its need to take aids andgrants from other countries to tide over difficulties.

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Anton Shorey-Okoronkwo added this note
Trade barriers: these affect the BOP as the barriers arerected by other economies against the exports from a country, the lower will be the demand for its exports a hence for its currency (Khetan, 2014)
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