Department of Business

Administration

MACRO ECONOMICS
Course Code: ECO 144
Program: BBA-2ND
Credit Hours: 03
Instructor: Muhammad Irfan Khan
(Assistant Professor)
 WEEK 15 (Lecture – 1)
Correction of Deficit in the
Balance of Payments of Pakistan.

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 The Contents for TODAY are;
 To describe the meaning of balance of payment deficit.
And.,
 To explain the corrective measures which are adopted to
correct the deficit in the balance of payments.

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 Deficit in the Balance of
Payments

In case of Balance of Payments Deficit;

• Supply for that Currency will be Less than its
Demand.
• Currency will be Devalued.
• Official Reserves can be used to Support
Currency.

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 Remedial Measures to Correct the
Deficit in the BOP
GENERALLY, FOUR METHODS ARE ADOPTED TO
CORRECT DISEQUILIBRIUM IN BOP.

 Trade Policy Measures: Expanding Exports and

Restraining Imports.
 Expenditure Reducing Policies.
 Expenditure Switching Policies: Devaluation.

 Exchange Control.

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 TRADE POLICY MEASURES
Trade policy measures are adopted to improve the balance of
payments of the country. This action refers to the measures
Which are adopted to promote the volume of exports and to
reduce the volume of imports.

As if increase occurs in the level of exports, the country will be

able to earn more foreign exchange, so its import bill can be
reduced which mitigates the pressure on balance of
payments.
Similarly, when a country becomes able to reduce its imports, it
finds the way to cut the import bill which give rise to debit in
the balance of payments record.

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 TRADE POLICY MEASURES
(Cond…)
Hence with increasing exports and decreasing
imports, the balance of payments can be improved.
Exports may be encouraged by reducing or
eliminating the export duties and lowering the
interest rate on credit which is used for financing
exports.
Exports may also be encouraged by granting
subsidies to manufacturers and exporters in the
country.
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 TRADE POLICY MEASURES
(Cond…)
In this regard;
• Lower income tax can be levied to provide incentives to
the exporters that they can produce and export more goods
and services.
• With the imposition of lower excise duties, the prices of
exports can be reduced to make their demand higher and to
make them competitive in the world market.
• Similarly, imports may be reduced by imposing or raising
tariffs such as import duties on imports of goods. Imports
may also be restricted through imposing import quotas and
ensuring licenses for imports etc. Imports of the inessential
items may be totally and strictly prohibited.

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 EXPENDITURES REDUCING
POLICIES
Reducing imports and thereby reducing the deficit in the
balance of payments is the strategy for which the policy
makers prefer the conduct and operations of sound and
effective monetary and fiscal policies in the country.
To reduce the aggregate expenditures and thereby to reduce
the deficit in the BOP, these policies are playing an
important role in the economy.
The fall in aggregate expenditure (aggregate demand) in
the economy works to reduce imports and help in solving
the balance of payments problem accordingly.

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 EXPENDITURES REDUCING
POLICIES
In this way, the following two important tools are used to reduce
the aggregate expenditure in the economy (to achieve the goal):

(1)Tight Monetary Policy

And.,

(2) Contractionary Fiscal Policy

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 TIGHT MONETARY POLICY
Monetary policy is used to control credit and money supply in
circulation.
Tight monetary is the stance of monetary policy which is
often used to check aggregate expenditures by raising the
cost of bank credit and restricting the availability of
credit.
For this, the central bank of the country raise the bank rate
which in return leads to increase the lending rates
charged by the commercial banks. This discourages
businessmen to borrow money for investment and
consumers to borrow that for buying durable consumers
goods and so on…
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 CONTRACTIONARY
FISCAL POLICY
Fiscal policy is used to deal with taxes and expenditures in the country.
The conduct of an appropriate and sound fiscal policy is an important
way to reduce aggregate expenditures in the country.
An increase in direct taxes (like income tax) will reduce aggregate
expenditures. A part of reduction in expenditure may lead to decrease
in imports.
Increase in indirect taxes (like sales tax and excise duty) will also
cause reduction in expenditures.

Reduction in the Government expenditures, especially unproductive

or non-developmental expenditures will not only reduce expenditure
directly but also indirectly through the operation of multiplier.

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 Expenditure Switching Policies
(Devaluation).
This method is used significantly to correct especially the
fundamental disequilibrium in the balance of payments.
Expenditure switching policies work through changes in the
relative prices.
On one side, prices of imports are increased by making
domestically produced goods relatively cheaper (as compared to
goods imported).
While on the other hand, the expenditure switching policies may
lower the prices of exports which will encourage exports of a
country in the world market.
In this way by changing relative prices, expenditure switching
policies help in correcting the emerged disequilibrium in
balance of payments.
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 Expenditure Switching Policies
(Devaluation).,…. ((Cond))…
The important form of expenditure switching policy is the
reduction in foreign exchange rate of the national
currency which we know that by currency devaluation.
By devaluation we mean, the reduction in the value or
exchange rate of a national currency with respect to the
currencies of the rest of the world.

Remind, devaluation is made when a country is under

fixed exchange rate system and decides to lower the
exchange rate of its currency (whenever they feel need)
to improve its balance of payments.

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 EXCHANGE CONTROL.
This is another useful method called exchange control which is used
to correct the disequilibrium in the BOP.

Decreasing prices (as discussed earlier) may lead to deflation in

economy which is also a dangerous situation for an economy,
similarly, devaluation has a temporary effect which can also affect
the prestige of a country and at the same time, it may also provoke
others for devaluation.

So, these methods are, therefore, not highly recommended for each
time, these are avoided and instead foreign exchange is controlled by
the Government to make corrections in the balance of payments
accordingly.

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 EXCHANGE CONTROL
(Cond…)
Under this system, all the exporters are ordered to
surrender their foreign exchange to the central bank
of the country and it is then rationed out among the
licensed importers. No one else is allowed to
import
goods without the license.

The balance of payments is thus rectified by

keeping the imports within limits which lead to
make corrections respectively.
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 IN SHORT…
Correction of disequilibrium requires a careful
combination of the following measures/methods;
• Monetary and fiscal changes to affect the income and
prices in the country;
• Exchange rate adjustment, such as, devaluation or
appreciation of the home currency;
• Trade restrictions, such as, tariffs, quotas, etc.,
• Capital movement, i. e., borrowing or lending operations
aboard;……………….. and,.,
• Exchange control.

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 CONCLUDING…

Now you should be able to know,,,,,

 About the conceptual understanding on the
balance of payments’ deficit.

And.,
 About the various measures which are adopted to
correct the deficit in the in the balance of Payments.

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Thank You…