What is the Equilibrium and Disequilibrium in the Balance of Payments ?
When we add up all the demand for foreign currency and all the sources from where it comes, these two accounts are necessarily equal, then the overall account of balance of payments must be in equilibrium.
Equilibrium or disequilibrium in balance of payments refers to the balance on those parts of accounts which do not include the accommodating items such as borrowing from the IMF, use of SDR’s, drawing from the reserves of foreign currencies held by Central Bank etc. After excluding these accommodating items, when there is neither deficit nor surplus, then the balance of payments said to be in equilibrium. If there is either deficit or surplus, then the balance of payments will be in disequilibrium. The deficit in balance of payments can be financed by drawing from the IMF, use of SDR’s, drawing from the reserves of foreign currencies etc.
Basic Balance of Payments, Autonomous Items and Accommodating Items –
The concept of basic balance is based on the idea of autonomous items in the balance of payments. The autonomous items in the balance of payments are those items which cannot be influenced or changed so easily or quickly by the government and they are determined by some long term factors.
In the concept of basic balance, besides the items in the current account, the long term capital movements both on private and government account contained in the capital account balance of payments are regarded as autonomous.
While in the capital account short term capital movements such as borrowing from IMF or from Central Banks of other countries, drawing from SDR, change in foreign exchange reserves are transitory and of accommodating nature and are therefore excluded from the concept of basic balance in the balance of payments.
Equilibrium is a state of balance which can be sustained without intervention of the Government.
Representation of the concept of balance of payments –
(X-M) + LTC = 0
X = Exports including Visible Items
M = Imports including Visible Items
LTC = Long Term Capital Movements
If (X-M) is positive (X>M), then the balance of payments to be in equilibrium, LTC will be -ve and equal to (X-M). This means that there will be net capital outflow.
If M>X, then for the balance of payments to be in equilibrium LTC must be +ve. This means that there will be net capital inflow to offset the deficit in the current account.
When the balance of payments of a country is in equilibrium, the demand for the domestic currency is equal to the supply of its domestic currency. That means the demand and supply situation is neither favourable nor unfavourable.
When the balance of payments of a country moves against a country, adjustments made by encouraging exports of goods, services or by discouraging imports of all kinds. No country can have a permanent unfavourable balance of payments. Total liabilities and total assets of nations as of individuals, must balance in the long run to be in equilibrium.
This does not mean that the balance of payments of a country should be in equilibrium individually with every other country with which it has trade relations. This is not necessary and it doesn’t happens in the real world situations. In the real world there is a multilateral trade system.
For example, India may have balance of payments deficit with the US and surplus with the UK and/or other countries, but each country, in the long run, cannot receive more value than it has exported to exported to other countries taken together.
Equilibrium in the balance of payments is a sign of soundness of a country’s economy. But disequilibrium may arise in the short periods or in the long periods.
A continued disequilibrium indicates that the country is heading towards economic instability and financial bankruptcy. So, every country must try to maintain balance of payments in equilibrium.