FACTORS AFFECTING BALANCE OF PAYMENTS

Export of Goods And Services

The Prevailing Exchange Rate of the Domestic Currency: A lower value of the
domestic currency results in the domestic price getting translated into a lower
international price. This increases the demand for domestic goods and services and
hence their export. This is likely to result in a higher demand for the domestic
currency. A higher exchange rate would have an exactly opposite effect.
Inflation Rate: The inflation rate in an economy vis-à-vis other economies affects the
international competitiveness of the domestic goods and hence their demand. Higher
the inflation, lower the competitiveness and lower the demand for domestic goods.
Yet, a lower demand for domestic goods and services need not necessarily mean a
lower demand for the domestic currency. If the demand for domestic goods is
relatively 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 the
demand 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 to
domestic inflation, the price increases to Rs.530 per quintal and there is a resultant
fall in the quantity demanded to 96 quintals. The exports would increase from
Rs.50,000 to Rs.52,800 instead of falling.
World Prices of a Commodity: If the price of a commodity increases in the world
market, the value of exports for that particular product shows a corresponding
increase. This would result in an increase in the demand for the domestic currency. A
fall in the demand for domestic currency would be experienced in case of a reduction
in the international price of a commodity. This impact is different from the previous
one. The previous example considered an increase in the domestic prices of all goods
produced in an economy simultaneously, while this one considers a change in the
international price of a single commodity due to some exogenous reasons.
Incomes of Foreigners: There is a positive correlation between the incomes of the
residents 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 (and
hence, an increase in the incomes of the residents) of such an economy will result in
an increase in the exports of the domestic economy Once again, this would increase
the demand for the local currency.
Trade Barriers: Higher the trade barriers erected by other economies against the
exports from a country, lower will be the demand for its exports a hence, for its
currency.
Imports of Goods and Services
Imports of goods and services are affected by the same factors that affect the
exports. 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 results
in making imported goods and services cheaper in terms of domestic currency, hence
increasing their demand. The increased demand imports results in an increased
supply of the domestic currency depreciation of the domestic currency have an
opposite effect.
Level of Domestic Income: An increase in the level of domestic income increases
the demand for all goods and services, including imports and it results in an increased
supply of the domestic currency.
International Prices: The. International demand and supply positions deter the
international price of a commodity. A higher international price would translate into a
higher domestic price. If the demand for imported goods is inelastic, this would result
in a higher domestic currency value of in increasing the supply of the domestic
currency.
In case of the demand elastic, the effect on the supply of the domestic currency would
depend the effect on the domestic currency value of imports.
Inflation Rate: A domestic inflation rate that is higher than the inflation of other
economies, would result in imported goods and services bee relatively cheaper than
domestically 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 the
barriers, 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 on
the level of past investments and the current rates of return that can be earned in an
economy. For payments, it is the level of past foreign investments and the current
domestic rates of return; while for the receipts it is the past domestic investments in
foreign 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 migrants
to or from a country, who may receive money from or send money to relatives. The
second is the desire of a country to generate goodwill by granting aids to other
countries along with the economic capability to do so, or its need to take aids and
grants from other countries to tide over difficulties.
Capital Account Transactions
Four major factors affect international capital transactions. The foremost is the rate of
return which can be earned on the investments as compared to the returns that can
be earned on domestic investments. The higher the differential returns offered by a
country, the higher will be the capital inflows. Another factor is the additional risk that
accompanies these returns. More the risk, lower the capital inflows. Diversification
across countries may offer some extra benefit in addition to the returns offered by a
particular investment. This benefit arises from the fact that different economies may
be at different stages of economic cycle at a given time, thus making their
performance unrelated. Higher the diversification benefits, higher the inflows. One
more factor, which has a very significant affect on these transactions, is the expected
movement in the exchange rates. If the exchange rates are quite stable, or the
movement is expected to be in the investors' favor, the capital inflows will be higher.